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 $170,000, and it would cost another $34,000 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 $42,500. The applicable depreciation rates are 33%, 45%, 15%, and 7%. The equipment would require an $8,000 increase in net operating working capital (spare parts inventory). The project would have no effect on revenues, but it should save the firm $29,000 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.

Explanation / Answer

Step1: Initial investment outlay at Zero year:

Step2: Project's Annual Cash flows:

* loss on tax is cash inflows

# Terminal cash flows:

1)Book value asset at end of 3rd year( $204,000 - $189,720) = $14,280

2) Sales proceeds = $42,500

3) Capital gain (2-1) = $28,220

4) Tax (40%) = $11,288

5) net salvage value (cash inflow) ( 2-4) = $31,212

Terminal cash inflows: * $8,000 + $ 31,212 = 39,212

* assume working capital recovered at end of the project.

Equipment cost $ 170,000 additional expenditure (modification) $ 34,000 Total Capital Expenditure $204,000 Add: Working capital required $8,000 Total cash outlay at Year 0 $212,000

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