You must evaluate the purchase of a spectrometer for the R&D department. The bas

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%.

What is the initial investment outlay for the spectrometer, that is, what is the Year 0 project cash flow?

-$11,100

-$11,000

-$10,300

-$11,900

-$11,800

What is the project's Free Cash Flow in Year 1?

$2,337

$6,000

$3,663

$1,402

$5,065

What is the project's Free Cash Flow in Year 2?

$5,598

$4,995

$603

$6,000

$1,005

What is the project's Free Cash Flow in Year 3?

$1,301

$4,335

$4,266

$2,601

$6,000

$6,367

Explanation / Answer

Cost savings $ 6,000 Less: Depreciation $ 1,665 Profit before tax $ 4,335 Less: Tax $ 1,734 Net income $ 2,601 Add: Depreciation $ 1,665 Free cash flows year 3 $ 4,266

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