New project analysis You must evaluate a proposed spectrometer for the R&D depar
ID: 2719518 • Letter: N
Question
New project analysis
You must evaluate a proposed spectrometer for the R&D department. The base price is $280,000, and it would cost another $70,000 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 $98,000. The applicable depreciation rates are 33%, 45%, 15%, and 7%. The equipment would require an $12,000 increase in net operating working capital (spare parts inventory). The project would have no effect on revenues, but it should save the firm $71,000 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 11%, should the spectrometer be purchased?
-Select-yesnoItem 5
Explanation / Answer
1) Cash outflow in year 0 = Base price + Cost to modify +Working capital requirement
= 280000+70000+12000
= 362000
Cost of spectometer = Base price + Modifications
Depreciation in year 1 = 33%*350000 i.e 115500
Depreciation in year 2 =45%*350000 i.e 157500
Depreciation in year 3 =15%*350000 i.e 52500
Value of machine after 3 years = 350000-115500-157500-52500 i.e 24500
Gain on sale of machinery after 3 years = 98000-24500 i.e 73500
Calculation of cash inflows
Year 1 = Savings in cost ( net of tax ) +Savings of tax on depreciation
=71000(0.60) +115500(0.40)
= 88800
Year 2 = Savings in cost( net of tax )+ tax saving on depreciation
= 71000(0.60)+157500(0.40)
= 105600
Year 3 = Savings in cost ( net of tax ) +Tax saving on depreciation + Salvage value - Tax on capital gain+ Working capital
= 71000(0.60) + 52500(0.40) +98000-73500(0.40)+12000
= 42600+21000+98000-29400+12000
= 144200