Problem 12-8 New project analysis You must evaluate a proposed spectrometer for
ID: 2733625 • Letter: P
Question
Problem 12-8 New project analysis
You must evaluate a proposed spectrometer for the R&D department. The base price is $70,000, and it would cost another $10,500 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 $17,500. The applicable depreciation rates are 33%, 45%, 15%, and 7%. The equipment would require an $10,000 increase in net operating working capital (spare parts inventory). The project would have no effect on revenues, but it should save the firm $23,000 per year in before-tax labor costs. The firm's marginal federal-plus-state tax rate is 40%.
A. 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.
B. What are the project's annual cash flows in Years 1, 2, and 3? Round your answers to the nearest cent.
C. If the WACC is 11%, should the spectrometer be purchased? ( yes or no)
Explanation / Answer
A) INITIAL INVESTMENT OUTLAY: Cost of the spectometer 70000 cost of modification 10500 increase in net working capital 10000 90500 B) ANNUAL CASH FLOWS: 1 2 3 savings in labor cost 23000 23000 23000 less: depreciation 26565 36225 12075 net savings before tax -3565 -13225 10925 tax @ 40% -1426 -5290 4370 savings after tax -2139 -7935 6555 ass: depreciation 26565 36225 12075 cash flows after tax 24426 28290 18630 release of NWC 10000 salvage value 17500 tax on gain 40% of 17500 - 5635 -4746 Annual cash flows 24426 28290 41384 pvif at 11% 0.9009 0.8116 0.7312 PV 22005 22961 30260 Cumulative PV 75226 C) NPV: PV of cash inflows 75226 Initital investment 90500 -15274 As the NPV is negative the spectometer should not be purchased.