Problem 12-8 New project analysis You must evaluate a proposed spectrometer for
ID: 2767881 • Letter: P
Question
Problem 12-8 New project analysis You must evaluate a proposed spectrometer for the R&D department. The base price is $170,000, and it would cost another $42,500 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 $59,500. 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 $72,000 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. If the WACC is 10%, should the spectrometer be purchased?
Explanation / Answer
Answer 1 Initial outlay for spectometer Base price $1,70,000 Modification cost $42,500 Spare parts $5,000 Total Initial Outlay $2,17,500 Answer 2 Project annual cash flow Year Saving in labour cost before tax Tax rate Saving in labour cost after tax Depreciation as per MACRS Saving in Tax due to depreciation Total Cash Saving / Cash flow A B C = A*60% D E = D * 40% C + E 1 $72,000.00 40% $43,200.00 $70,125.00 $28,050.00 $71,250.00 2 $72,000.00 40% $43,200.00 $95,625.00 $38,250.00 $81,450.00 3 $72,000.00 40% $43,200.00 $31,875.00 $12,750.00 $55,950.00 Capitalised cost of spectometer = $212500 Answer 3 Calculation of NPV of the project at 10% WACC Year Cash flow PV Factor 2 10% Present value 0 -$2,17,500 1 -$2,17,500.00 1 $71,250 0.909090909 $64,772.73 2 $81,450 0.826446281 $67,314.05 3 $55,950 0.751314801 $42,036.06 Salvage value of equipment $59,500 0.751314801 $44,703.23 Net present value $1,326.07 As the net present value of the project is positive i.e.$1326.07, the spectometer should be purchased.