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 $260,000, and it would cost another $39,000 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 $65,000. The applicable depreciation rates are 33%, 45%, 15%, and 7%. The equipment would require an $11,000 increase in net operating working capital (spare parts inventory). The project would have no effect on revenues, but it should save the firm $70,000 per year in before-tax labor costs. The firm's marginal federal-plus-state tax rate is 40%.

a) 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.

b) What are the project's annual cash flows in Years 1, 2, and 3? Round your answers to the nearest cent.

Explanation / Answer

b)project's annual cash flows in Years 1, 2, and 3

Particulars

a) initial investment outlay for the spectrometer in the year $ Cost of equipment 260000 Cost to modify asset 39000 299000

b)project's annual cash flows in Years 1, 2, and 3

Particulars

$ Year 1 2 3 Savings in cost 70000 70000 70000 Less:Depreciation (Note) 98670 90149 16527 Wotking capital 11000 11000 11000 Cash flows before tax -39670 -31149 42473 Tax@40% -15868 -12459 16989 CFAT before depreciation -23802 -18689 25484 Add: Depreciation 98670 90149 16527 CFAT 74868 71459 42011 Note : Declining method Cost Depreciation Year 1 Year 2 Year 3 Year 4 Opening value 299000 200330 110182 93654 Depreciation Rates 0.33 0.45 0.15 0.07 Depreciation 98670 90149 16527 6556 Written down value 200330 110182 93654 87098

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