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

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New project analysis

You must evaluate a proposed spectrometer for the R&D department. The base price is $90,000, and it would cost another $18,000 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 $31,500. The applicable depreciation rates are 33%, 45%, 15%, and 7%. The equipment would require an $6,000 increase in net operating working capital (spare parts inventory). The project would have no effect on revenues, but it should save the firm $76,000 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 13%, should the spectrometer be purchased?
-Select-yesnoItem 5

Explanation / Answer

1) Initial investment outlay in the year 0 will be :-

a) Cost of Instrument -                        $ 90000

b) Cost of Modification-                       $ 18000

c) Working capital Requirment-          $   6000

Total Outflow                                      $ 114000.

2) Projected Annual Cash flows :-

$ Cost of equipment            90,000 Cost of Modification            18,000 Spares Cost              6,000 Initial outflow          114,000 Year 1 Year 2 Year 3 Total Depreciation Rate 33% 45% 15% Amount of Depreciation           37,620           51,300           17,100    106,020 Tax Saving on Depreciation @ 40%           15,048           20,520              6,840 WDV after 3 years = $ 114000- $ 106020 = $ 7980 Sale value of Machinery after 3 years = $ 31500 Gain on sale of Machinery = $ 31500- $ 7980 = 23520. Tax on Gain of Machinery = $ 23520 X 40% = 9408 Cash flow from the equipment Year 1 Year 2 Year 3 Saving in Labour cost $           76,000           76,000           76,000 Additional Tax on saving on labour a@ 40% $         (30,400)         (30,400)         (30,400) Tax Saving on Depreciation $           15,048           20,520              6,840 Sale of Machinery           31,500 Tax on Gain of Machinery $           (9,408) Net Cash Flow $           60,648           66,120           74,532 Discount Rate Factor @ 13%              0.885              0.783              0.693 Discounted Cash Flow $           53,671           51,782           51,654

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