You have been asked by the President of your company to evaluate the proposed ac
ID: 2623940 • Letter: Y
Question
You have been asked by the President of your company to evaluate the proposed acquisition of a new spectrometer for the firm's R&D department. The equipment's basic price is $70,000, and it would cost another $10,750 to modify it for special use by your firm. The spectrometer, which falls into the MARCS 3-year class, would be sold after 3 years for $30,000. Use of the equipment would require an increase in net working capital (spare parts inventory) of $4,000. The spectrometer would have no effect on revenues, but it is expected to save the firm $25,000 per year in before-tax operating costs, mainly labor. The firm's marginal federal-plus-state tax rate is 40%.
a. What is the net cost of the spectrometer (i.e., the Year-0 Net Cash Flow)
b. What are the net operating cash flows in Years 1, 2 and 3?
c. What is the additional (non-operating) cash flow in Year 3?
d. If the project's cost of capital is 10%, should the spectrometer be purchased?
Explanation / Answer
Information given:
Basic Price: $70,000
Another cost for modification: $15,000
Spare parts inventory: $4,000
Equipment can be sold after 3 years for: $30,000
Before Tax Savings: $25,000
Tax rate: 40%
a. What is the net cost of the spectrometer? (That is, what is the Year-0 net cash flow?)
Net cost of the spectrometer:
Basic Price
$70,000
Modification cost
$15,000
Increase in working capital
$4,000
Net Cost
$89,000
b. What are the net operating cash flows in Years 1, 2, and 3?
Operating cash flow
Basic Price
$70,000
Modification cost
$15,000
Increase in working capital
$4,000
Net Cost
$89,000
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