you must evaluate a proposed spectrometer for the R&D department. the base price

Question

you must evaluate a proposed spectrometer for the R&D department. the base price is $140,000 and it would cost another $30,000 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 $60,000. the applicable depreciation rates are 33%, 45%, 15% and 7%. the equipment would require an $8000 increase in working capital (spare parts inventory). the project would have no effect on revenues, but it should save the firm $50,000 per year in before-tax labor costs. the firms marginal federal plus state tax rate is 40%.

a. what is the net cost of the spectrometer; that is, what is the year 0 project cash flow?

b. what are the projects annual net cash flows in year 1,2 and 3?

c. if the WACC is 12%, should the spectrometer be purchased? explain.

Explanation / Answer

a.       Net cost of the sprctrometer at 0 year cash flows is = $140,000 + $30,000                                                                                     =$170,000 b.       Calulation of annual net cash flows for the year 1, 2 and 3.       MACRS Depreciation for 3 years at 33%, 45% and 15%.              Year Intial cost MACRS EBIT Taxes(40%) EBIT-Taxes Net income+Depreciation 1 170,000 56100 50,000 20000 30,000 86,100 2 170,000 76500 50,000 20000 30,000 106,500 3 170,000 25500 50,000 20000 30,000 55,500 This net income + Depreciation is nothing but the Cash flows for the year 1,2 and 3. c.    WACC is 12%.    Calculation of IRR:             By using excel spread sheet function, inset IRR in formula bar and take the values as follows.                      -170000, 86,000, 106,500, 55,500. By enter we can get value as 23%.             But actual WACC is 12%, The IRR is 23%. Therefore we can accept the project because it is giving more return than WACC.              Year Intial cost MACRS EBIT Taxes(40%) EBIT-Taxes Net income+Depreciation 1 170,000 56100 50,000 20000 30,000 86,100 2 170,000 76500 50,000 20000 30,000 106,500 3 170,000 25500 50,000 20000 30,000 55,500

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