You must evaluate a proposed spectrometer for the R&D department. The base price

Question

You must evaluate a proposed spectrometer for the R&D department. The base price is $190,000, and it would cost another $47,500 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 $57,000. The applicable depreciation rates are 33%, 45%, 15%, and 7%. The equipment would require an $13,000 increase in net operating working capital (spare parts inventory). The project would have no effect on revenues, but it should save the firm $57,000 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 14%, should the spectrometer be purchased?

Explanation / Answer

Initial Investment / Cash Flow in year 0

                    = Cost of Equipment + Increase in working capital = 237500 + 13000 =$250,500

Cash Flows in Years 1 and 2

               = (Saving in Labour Cost - Depreciation) * (1 - Tax Rate) + Depreciation

Cash Flow in year 3

            = (Saving in Labour Cost - Depreciation) * (1 - Tax Rate) + Depreciation + Recovery of Working Capital + After Tax Salvage Value

After Tax Salvage Value = Salvage Value - (Salavage Value - Book Value) * Tax Rate

                                         = 57000 - (57000 - 16625) * 0.4 = $40,850

If WACC is 14%, the net present value of the project is -$64,739.89. Since NPV is negative, the barometer should not be purchased.

Year Cost of Equipment= Base price + Modifcation Cost Working Capital Saving in Labour Cost Depreciation(%) Depreciation Book Value Salvage Value After Tax Salvage Value Cash Flow Discounted Cash Flow at 14% 0 237500 13000 0 0 0 237500 0 0 -250500 -250500.00 1 0 0 57000 33% 78375 159125 0 0 65550 57500.00 2 0 0 57000 45% 106875 52250 0 0 76950 59210.53 3 0 -13000 57000 15% 35625 16625 57000 40850 102300 69049.59 NET PRESENT VALUE -64739.89

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