You have been asked by the president of your company to evaluate the proposed ac
ID: 2674333 • Letter: Y
Question
You have been asked by the president of your company to evaluate the proposed acquisition of a new spectrometer for the fir's R&D department. The equipment's basic price is $70,000, and it would cost another $15,000 to modify it for special use by your firm. the spectrometer, which falls into the MACRS 3-year class, would be sold after 3 years for $30,000. Use of the equipment would require an increase in net working captial (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 cost, mainly labor. The firm's marginal federal-plus-state tax rate of 40%. a. What is the next cost of the spectrometer! (That is, what is the Year-0 net cash flow?) b. What are the net operating cash flows in Year 1, 2, and 3? c. What is the additional (nonoperatintg) cash flow in Year 3? d. If the project's cost of capital is 10%, should the spectrometer be purchased?Explanation / Answer
What is the next cost of the spectrometer! (That is, what is the Year-0 net cash flow?)
Price ($70,000)
Modification (15,000)
Change in NWC (4,000)
Net Cost 89 000
========================================
after-tax cost savings is $25,000(1 – T) = $25,000(0.6)= $15,000.
What are the net operating cash flows in Year 1, 2, and 3?
Year 1 Year 2 Year 3
After-tax savings $15,000 $15,000 $15,000
Depreciation shield 11,220 15,300 5,100
Operating cash flow $26,220 $30,300 $20,100
==================
What is the additional (nonoperatintg) cash flow in Year 3?
Salvage value $30,000
Tax on Sv (9,620)
Return of NWC 4,000
Additional end-of-project cash flow $24,380
tax on SV = ($30,000 - $5,950)(0.4) = $9,620.
The remaining Book Value in Year 4 = $85,000(0.07) = $5,950.
d. If the project's cost of capital is 10%, should the spectrometer be purchased?
Year
Cash Fow
0
($89,000)
1
$26,220
2
$30,300
3
$44,480
NPV
($6,703.83)
Year
Cash Fow
0
($89,000)
1
$26,220
2
$30,300
3
$44,480
NPV
($6,703.83)
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