New project analysis You must evaluate a proposed spectrometer for the R&D depar
ID: 2762556 • Letter: N
Question
New project analysis
You must evaluate a proposed spectrometer for the R&D department. The base price is $290,000, and it would cost another $72,500 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 $101,500. The applicable depreciation rates are 33%, 45%, 15%, and 7%. The equipment would require an $5,000 increase in net operating working capital (spare parts inventory). The project would have no effect on revenues, but it should save the firm $73,000 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?
-Select-yesnoItem 5
Explanation / Answer
1.
Initial investment outlay = Base price of equipment + Modification cost + Net working capital investment = $290,000 + $72,500 + $5,000 = $367,500
2.
Year
1
2
3
Savings in labor costs
$ 73,000.00
$ 73,000.00
$ 73,000.00
Depreciation ($362500 * rate)
$ 119,625.00
$ 163,125.00
$ 54,375.00
Net savings
-$ 46,625.00
-$ 90,125.00
$ 18,625.00
Tax @ 40%
$ 0.00
$ 0.00
$ 7,450.00
Savings after tax
-$ 46,625.00
-$ 90,125.00
$ 11,175.00
Add: Depreciation
$ 119,625.00
$ 163,125.00
$ 54,375.00
Annual cash flow
$ 73,000.00
$ 73,000.00
$ 65,550.00
Sale of equipment
$ 71,050.00
Release of net working capital
$ 5,000.00
Free cash flow
$ 73,000.00
$ 73,000.00
$ 141,600.00
Book value of equipment at the end of year 3 = $362,500 - $337,125 = $5,375
Salvage value = $101,500
Gain on sale = $101,500 - $5,375 = $76,125
Tax gain on sale = $76,125 * 0.40 = $30,450
Net receipt on sale of equipment = $101,500 - $30,450 = $71,050
3.
Year
Cash flow
Present value factor @ 12%
Present value of cash flow
0
-$ 367,500.00
1
-$ 367,500.00
1
$ 73,000.00
0.8929
$ 65,181.70
2
$ 73,000.00
0.7972
$ 58,195.60
3
$ 141,600.00
0.7118
$ 100,790.88
Net present value
-$ 143,331.82
Since NPV is negative, spectrometer should not be purchased.
Year
1
2
3
Savings in labor costs
$ 73,000.00
$ 73,000.00
$ 73,000.00
Depreciation ($362500 * rate)
$ 119,625.00
$ 163,125.00
$ 54,375.00
Net savings
-$ 46,625.00
-$ 90,125.00
$ 18,625.00
Tax @ 40%
$ 0.00
$ 0.00
$ 7,450.00
Savings after tax
-$ 46,625.00
-$ 90,125.00
$ 11,175.00
Add: Depreciation
$ 119,625.00
$ 163,125.00
$ 54,375.00
Annual cash flow
$ 73,000.00
$ 73,000.00
$ 65,550.00
Sale of equipment
$ 71,050.00
Release of net working capital
$ 5,000.00
Free cash flow
$ 73,000.00
$ 73,000.00
$ 141,600.00