New project analysis You must evaluate a proposed spectrometer for the R&D depar
ID: 2716446 • Letter: N
Question
New project analysis
You must evaluate a proposed spectrometer for the R&D department. The base price is $230,000, and it would cost another $34,500 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 $80,500. The applicable depreciation rates are 33%, 45%, 15%, and 7%. The equipment would require an $6,000 increase in net operating working capital (spare parts inventory). The project would have no effect on revenues, but it should save the firm $60,000 per year in before-tax labor costs. The firm's marginal federal-plus-state tax rate is 40%.
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.
$
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 $
If the WACC is 12%, should the spectrometer be purchased?
yes or no
Explanation / Answer
Initial investment outlay = -Base Price - Modification cost for special use - increase in net operating working capital
Initial investment outlay = -230000-34500-6000
Initial investment outlay = -270500
2)
Machine Cost = Base Price + Modification cost for special use
Machine Cost = 230000+34500
Machine Cost = 264500
Annual cash flows in Years 1 = Saving in before-tax labor costs *(1-tax rate) + Depreciation Tax shield
Annual cash flows in Years 1 = 60000*(1-40%) + 264500*33%*40%
Annual cash flows in Years 1 = 70914
Annual cash flows in Years 2 = Saving in before-tax labor costs *(1-tax rate) + Depreciation Tax shield
Annual cash flows in Years 2= 60000*(1-40%) + 264500*45%*40%
Annual cash flows in Years 2 = 83610
Terminal Value = post tax salvage value + workig capital realised back
Terminal Value = (80500-40%*(80500-7%*264500)) + 6000
Terminal Value = 61706
Annual cash flows in Years 3 = Saving in before-tax labor costs *(1-tax rate) + Depreciation Tax shield + Terminal Value
Annual cash flows in Years 3= 60000*(1-40%) + 264500*15%*40%+61706
Annual cash flows in Years 3 = 113576
If the WACC is 12%, should the spectrometer be purchased?
NPV = - 270500 + 70914/1.12 + 83610/1.12^2 + 113576/1.12^3
NPV = -59689.40
Decsion : No , spectrometer should not be purchased as its NPV is negative