New project analysis You must evaluate a proposed spectrometer for the R&D depar

Question

New project analysis

You must evaluate a proposed spectrometer for the R&D department. The base price is $240,000, and it would cost another $60,000 to modify the equipment for special use by the firm. The equipment falls into the MACRS 3-year class and would be sold after 3 years for $120,000. The applicable depreciation rates are 33%, 45%, 15%, and 7%. The equipment would require an $11,000 increase in net operating working capital (spare parts inventory). The project would have no effect on revenues, but it should save the firm $48,000 per year in before-tax labor costs. The firm's marginal federal-plus-state tax rate is 40%.

What is the initial investment outlay for the spectrometer, that is, what is the Year 0 project cash flow? Round your answer to the nearest cent.
$  

What are the project's annual cash flows in Years 1, 2, and 3? Round your answers to the nearest cent.
in Year 1 $  
in Year 2 $  
in Year 3 $  

If the WACC is 14%, should the spectrometer be purchased?

Explanation / Answer

What is the initial investment outlay for the spectrometer, that is, what is the Year 0 project cash flow? Round your answer to the nearest cent. $   -311000 is the Year 0 Project Cash Flow, since there will be no income and only investment costs (Base price + Modification costs + Increase in Working Capital) What are the project's annual cash flows in Years 1, 2, and 3? Round your answers to the nearest cent. in Year 1 $   in Year 2 $   in Year 3 $   If the WACC is 14%, should the spectrometer be purchased? Annual Cash Flows yearwise Year 1 $ Year 2 $ Year 3 $ Savings per year 48000 48000 48000 Depreciation 54000 18000 8400 Profit before Taxes -6000 30000 39600 Taxation impact @ 40% NIL 12000 15840 Profit post taxes -6000 18000 23760 Annual Cash Flows (after adding depreciation back) 48000 36000 32160 If the WACC is 14%, the Net Present Value of the spectrometer needs to be calculated The same works out to -$ 130,208.06 Hence, since the Net Present Value is negative, the spectrometer should not be purchased.

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