You must evaluate the purchase of a spectrometer for the R&D department. The bas
ID: 2733689 • Letter: Y
Question
You must evaluate the purchase of a spectrometer for the R&D department. The base price is $11,000, and it would cost another $100 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 $1,650. The applicable depreciation rates are 33%, 45%, 15%, and 7%. The equipment would require an $800 increase in net operating working capital. The project would have no effect on revenues, but it should save the firm $6,000 per year in before-tax labor costs. The firm’s marginal federal-plus-state tax rate is 40%. 1)What is the initial investment outlay for the spectrometer, that is, what is the Year 0 project cash flow? 2)What is the project's Free Cash Flow in Year 1? 3)What is the project's Free Cash Flow in Year 2? 4)What is the project's Free Cash Flow in Year 3? 5)If the WACC is 10%, what is the project's NPV?
Explanation / Answer
1)INITIAL INVESTMENT OUTLAY
BASE PRICE $11000
MODIFICATION COST $100
INCREASE IN WORKING CAPITAL $800
INTIAL COST OF INVESTMENT $11900
YEAR DEPRECIATION RATE DEPRECIATION AMOUNT TAX SAVING SAVING IN LABOUR COST 1 33% $11100*33%=3663 3663*40%=$1465 $6000
2 45% $11100*45%=4995 4995*40%=$1998 $6000
3 15% $11100*15%=1665 1665*40%=$666 $6000
YEAR CASH FLOW/TOTAL SAVINGS PVF@ 10% PRESENT VALUE
1 $7465 1/1.1=.909 $6786
2 $7998 1/1.21=.826 $6606
3 $6666 1/1.331=.751 $5006
3 $800(RECOVERY OF W.C) .751 $601
3 $1650(SALE VALUE) .751 $1239
TOTAL PRESENT VALUE $20238
LESS:INITIAL OUTLAY $11900
NPV OF THE PROJECT $8338
*FREE CASH FLOW OF YEAR-3=$ 6666+$800+$1650=$9116
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