New project analysis You must evaluate a proposed spectrometer for the R&D depar
ID: 2625768 • Letter: N
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 $36,000 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 $8,000 increase in net operating working capital (spare parts inventory). The project would have no effect on revenues, but it should save the firm $44,000 per year in before-tax labor costs. The firm's marginal federal-plus-state tax rate is 40%.
Explanation / Answer
Hi,
Please find the detailed answer as follows:
Initial Investment = -240000 - 36000 - 8000 (Working Capital) = -284000
Annual Cash Flow Statement:
After Tax Cash Flow (Year 3 from Sale of Asset) = Sales Value of Asset +/- Tax Saving/Gain on the Sale of Asset
Gain = Sales Value - Book Value = 120000 - [276000- 276000*(33% + 45% + 15%)] = 100680
Tax on Gain = 100680*.40 = 40272
After Tax Cash Flow (Year 3) = 120000 - 40272 = 79728
Projected Cash Flows (from figures derived above):
Year 0 = -284000
Year 1 = 62832
Year 2 = 76080
Year 3 = 42960 + 79728 (Cash Flow from Sale of Asset) + 8000 (Recovery of Working Capital) = 130688
Thanks.
Year 1 Year 2 Year 3 Annual Savings 44000 44000 44000 Less Depreciation on (240000 + 36000) 91080 124200 41400 Savings after Depreciation but Before Tax -47080 -80200 2600 Less Taxes -18832 -32080 1040 Savings after Taxes -28248 -48120 1560 Add Depreciation 91080 124200 41400 Annual Cash Flow 62832 76080 42960