New-Project Analysis The president of the company you work for has asked you to
ID: 2654344 • Letter: N
Question
New-Project Analysis
The president of the company you work for has asked you to evaluate the proposed acquisition of a new piece of equipment for the firm’s R&D department The equipment's basic price is $100,000, and it would cost another $15,000 to modify it for special use by your firm. The equipment, which falls into the MACRS 3-year class, would be sold after 3 years for $45,000. Use of the equipment would require an increase in net working capital (spare parts inventory) of $6,000. The machine would have no effect on revenues, but it is expected to save the firm $30,000 per year in before-tax operating costs, mainly labor. The firm's marginal federal-plus-state tax rate is 30%.
A) What is the Year-0 net cash flow? If the answer is negative, use minus sign.
B) What are the net operating cash flows in Years 1, 2, and 3? Round your answers to the nearest dollar.
C) What is the additional (nonoperating) cash flow in Year 3? Round your answer to the nearest dollar.
D) If the project's cost of capital is 14%, should the chromatograph be purchased?
Year 1 $ Year 2 $ Year 3 $Explanation / Answer
A) In year 0, i.e. initial investment is in 2 tranches. One is purchase of equipment for $100,000 and modification charges of $15,000. Since both are cash outflows, net cash flow in year 0 is -$115,000
B) In year 1, There is increase in Working capital, means decrease in free cash flow. So -$6,000
And before tax savings in operating costs of $30,000. After tax would be 30,000 * (1-30%) = $21,000. So net cash flow in Year 1 is -6000+21000 = $15,000
In year 2, same transactions as above. Therefore net cash flow in Year 2 is $15,000
In year 3, same transactions as above. Therefore net cash flow in Year 3 is $15,000
C) In Year 3, there is an inflow of $45,000 from sale of equipment which, after tax it is $30,000
So net non-operating cash flow in Year 3 is $30,000
D) First calculate NPV of the project, to get net present value of the project we have to discount all cash flows to present values as shown in the below table
PV = CF / (1 + R)t
So NPV = sum of all PV’s = -$59,926.37
Since NPV is negative the chromatograph should not be purchased
Year Cash Flows PV 0 $ (115,000.00) $ (115,000.00) 1 $ 15,000.00 $ 13,157.89 2 $ 15,000.00 $ 11,542.01 3 $ 45,000.00 $ 30,373.72