You must evaluate the purchase of a proposed spectrometer for the R&D department

Question

You must evaluate the purchase of a proposed spectrometer for the R&D department. The base price is $270,000, and it would cost another $54,000 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 $67,500. The applicable depreciation rates are 33%, 45%, 15%, and 7%. The equipment would require a $10,000 increase in net operating working capital (spare parts inventory). The project would have no effect on revenues, but it should save the firm $31,000 per year in before-tax labor costs. The firm's marginal federal-plus-state tax rate is 40%.

a) 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. Negative amount should be indicated by a minus sign. $

b) 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 $

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

Explanation / Answer

Solution:

a) Calculation of the Initial Investment Outlay for the Spectrometer, that is the Year 0 Project Cash Flows:

Therefore, the Initial Investment Outlay for the Spectometer is $334,000.

b) Calculation of the Project's Annual Cash Flows in Years 1, 2 and 3:

c) Determining should the Spectrometer be Purchased:

Therefore, the Project has the Net Present Value of -$52,036 and the NPV is Negative. Thus, the Spectrometer Should not be Purchased.

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