The president of the company you work for has asked you to evaluate the proposed
ID: 2725513 • Letter: T
Question
The president of the company you work for has asked you to evaluate the proposed acquisition of a new chromatograph for the firm’s R&D department. The equipment's basic price is $90,000, and it would cost another $13,500 to modify it for special use by your firm. The chromatograph, which falls into the MACRS 3-year class, would be sold after 3 years for $22,500. The MACRS rates for the first three years are 0.3333, 0.4445, and 0.1481. Use of the equipment would require an increase in net working capital (spare parts inventory) of $4,500. The machine would have no effect on revenues, but it is expected to save the firm $27,000 per year in before-tax operating costs, mainly labor. The firm's marginal federal-plus-state tax rate is 40%.
a) What is the Year-0 net cash flow? If the answer is negative, use minus sign.
$
b) What are the net operating cash flows in Years 1, 2, and 3? Round your answers to the nearest dollar.
c) What is the additional (nonoperating) cash flow in Year 3? Round your answer to the nearest dollar.
$
d) If the project's after-tax cost of capital is 14%, should the chromatograph be purchased?
Year 1 $ Year 2 $ Year 3 $Explanation / Answer
Part A)
Year O cash outflow = cost of equipment + modification cost + increase in net working capital
= -90,000 – 13,500 -4,500
=-108,000
Part B)
year
Depreciation basis
MACRS rate
Depreciation
Tax shield
1
103500
0.3333
34496.55
13798.62
2
103500
0.4445
46005.75
18402.3
3
103500
0.1481
15328.35
6131.34
After tax savings = 27,000 x (1-0.40)
= 16,200
year
After tax savings
Depreciation Tax shield
Cash flow
1
16200
13798.62
29998.62
2
16200
18402.3
34602.3
3
16200
6131.34
22331.34
Part c)
Book value of asset at the end of year 3= 103,500 x 0.0741 = 7669.35
Non-operating cash flows = working capital recovered + net salvage value
= 4500 + (22500 – (22500 -7669.35)x0.40)
= 4500 +22500 – 5932.26
= 21067.74
Part d)
year
Cash flow
PV 14%
PV
0
-103500
1.0000
-103500.00
1
29998.62
0.8772
26314.58
2
34602.3
0.7695
26625.35
3
22331.34
0.6750
15073.02
3
21067.74
0.6750
14220.12
NPV
-21266.93
Since the NPV is negative, this project should not be undertaken and rejected.
year
Depreciation basis
MACRS rate
Depreciation
Tax shield
1
103500
0.3333
34496.55
13798.62
2
103500
0.4445
46005.75
18402.3
3
103500
0.1481
15328.35
6131.34
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