Please show all work: You have been asked by the president of your company to ev
ID: 2777934 • Letter: P
Question
Please show all work:
You have been asked by the president of your company to evaluate the proposed acquisition of a new spectrometer for the firm’s R&D department. The equipment’s basic price is $70,000 and it would cost another $15,000 to modify it for special use by your firm. The spectrometer, which has a MACRS 3-year recovery period, would be sold after 3 years for $30,000. Use of the equipment would require an increase in net working capital (spare parts inventory) of $4,000. The spectrometer would have no effect on revenues, but it is expected to save the firm $25,000 per year in before-tax operating costs, mainly labor. The firm’s marginal tax rate is 40 percent. If the project’s cost of capital is 10 percent, should the spectrometer be purchased?
Explanation / Answer
Calculation of Project's net cash Flows
Year 0
Year 1
Year 2
Year 3
Initial fixed asset investment (70000+15000)
$ (85,000.00)
Initial investment in net working capital
$ (4,000.00)
Tax Saving on depreciation = Dep * 40%
$ -
$ 11,332.20
$ 15,113.00
$ 5,035.40
Annual Saving in costs (Net of Tax) = 25000*(1-40%)
$ 15,000.00
$ 15,000.00
$ 15,000.00
Terminal Value of Assets (Net of tax) = (85000 - 850000*7.41%)*(1-40%)
$ 13,209.00
Net cash Flows
$ (89,000.00)
$ 26,332.20
$ 30,113.00
$ 33,244.40
Workings:
MACRS Depreciation and tax saving calculation:
Year 1
Year 2
Year 3
Cost of Asset
$ 85,000.00
$ 85,000.00
$ 85,000.00
MACRS Depreciation %
33.33%
44.45%
14.81%
Depreciation = Cost * Dep %
$ 28,330.50
$ 37,782.50
$ 12,588.50
Tax Saving on depreciation = Dep * 40%
$ 11,332.20
$ 15,113.00
$ 5,035.40
Calculation of Project's NPV
Year 0
Year 1
Year 2
Year 3
Net cash Flows (CF)
$ (89,000.00)
$ 26,332.20
$ 30,113.00
$ 33,244.40
PVF (10%)
1.00000
0.90909
0.82645
0.75131
PV = CF *PVF
$ (89,000.00)
$ 23,938.36
$ 24,886.78
$ 24,977.01
NPV = Sum of PVs
$ (15,197.85)
The NPV of the project is negative and hence it should not be purchased
Calculation of Project's net cash Flows
Year 0
Year 1
Year 2
Year 3
Initial fixed asset investment (70000+15000)
$ (85,000.00)
Initial investment in net working capital
$ (4,000.00)
Tax Saving on depreciation = Dep * 40%
$ -
$ 11,332.20
$ 15,113.00
$ 5,035.40
Annual Saving in costs (Net of Tax) = 25000*(1-40%)
$ 15,000.00
$ 15,000.00
$ 15,000.00
Terminal Value of Assets (Net of tax) = (85000 - 850000*7.41%)*(1-40%)
$ 13,209.00
Net cash Flows
$ (89,000.00)
$ 26,332.20
$ 30,113.00
$ 33,244.40
Workings:
MACRS Depreciation and tax saving calculation:
Year 1
Year 2
Year 3
Cost of Asset
$ 85,000.00
$ 85,000.00
$ 85,000.00
MACRS Depreciation %
33.33%
44.45%
14.81%
Depreciation = Cost * Dep %
$ 28,330.50
$ 37,782.50
$ 12,588.50
Tax Saving on depreciation = Dep * 40%
$ 11,332.20
$ 15,113.00
$ 5,035.40
Calculation of Project's NPV
Year 0
Year 1
Year 2
Year 3
Net cash Flows (CF)
$ (89,000.00)
$ 26,332.20
$ 30,113.00
$ 33,244.40
PVF (10%)
1.00000
0.90909
0.82645
0.75131
PV = CF *PVF
$ (89,000.00)
$ 23,938.36
$ 24,886.78
$ 24,977.01
NPV = Sum of PVs
$ (15,197.85)
The NPV of the project is negative and hence it should not be purchased
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