New project analysis You must evaluate a proposed spectrometer for the R&D depar
ID: 2724498 • Letter: N
Question
New project analysis You must evaluate a proposed spectrometer for the R&D department. The base price is $60,000, and it would cost another $9,000 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 $24,000. The applicable depreciation rates are 33%, 45%, 15%, and 7%. The equipment would require an $9,000 increase in net operating working capital (spare parts inventory). The project would have no effect on revenues, but it should save the firm $76,000 per year in before-tax labor costs. The firm's marginal federal-plus-state tax rate is 40%.
1. 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.
2. 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 $
3. If the WACC is 14%, should the spectrometer be purchased?
Explanation / Answer
a. What is the net cost of the spectrometer? (That is, what is the Year-0 net cash flow?) Price $ (60,000.00) Modification (9,000.00) Change in Net Working Capital (9,000.00) Net cost of spectrometer $ (78,000.00) After Tax Savings = $76,000 * (1-40%) = $76,000 * 0.60 $45,600 per year Year 1 Year 2 Year 3 Depreciation % per MACRS 33% 45% 15% Depreciation Expense $22,770 $31,050 $10,350 (Depreciation * Cost of Spectrometer) Depreciation Shield $9,108 $12,420 $4,140 (Depreciation * Tax Rate 40%) Year 1 Year 2 Year 3 After Tax Savings $45,600 $45,600 $45,600 Depreciation Shield $9,108 $12,420 $4,140 Net Operating Cash Flow $54,708 $58,020 $49,740 The depreciation expense in each year is the depreciable basis Price $ 60,000.00 Modification 9,000.00 Depreciable basis $ 69,000.00 Multiplied by MACRS allowance percentage of 33%, 45% and 15% for years 1, 2 and 3 respectively. The depreication shield is calculated as the tax rate 40% multiplied by the depreciation expense in each year d. If theWACC is 14%, should the spectrometer be purchased? Project's cost of capital 14% Year Total Cash Flow 0 $ (78,000) answer from a 1 $54,708 from b 2 $58,020 from b 3 $73,672 from b yr 3 and c addtl. End of project cash flow NPV: $64,360.48 Due to the investment having a positive NPV, it is recommended that the spectrometer be purchased.