You must evaluate a proposed spectrometer for the R&D department. The base price
ID: 2750116 • Letter: Y
Question
You must evaluate a proposed spectrometer for the R&D department. The base price is $160,000, and it would cost another $24,000 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 $72,000. 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 $76,000 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 $
Explanation / Answer
Base Price of Spectrometer = $ 160,000
Cost of Modification = $ 24,000
Increase in Net operating working capital = $ 8,000
Initial investment outlay / Year 0 cash flow = $ 160,000 + $ 24,000 + $ 8,000 = $ 192,000
Calculation of annual cash flows in years 1,2 and 3
Total cost of spectrometer = Base Price + cost of modification = $ 160,000 + $ 24,000 = $ 184,000
Applicable depreciation rates = 33% for first year, 45% for Second year, 15% for third year
Depreciation for year 1 = $ 184,000 * 33% = $ 60,720
Depreciation for year 2 = $ 184,000 * 45% = $ 82,800
Depreciation for year 3 = $ 184,000 * 15% = $ 27,600
Tax rate = 40%
Year 1
Year 2
Year 3
Savings in Labour costs
$76,000
$ 76,000
$ 76,000
Less: Depreciaiton
$ 60,720
$ 82,800
$ 27,600
Incremental EBIT
$ 15,280
-$6,800
$ 48,400
Tax on incremental EBIT at 40%
$ 6,112
0
$ 19,360
Incremental net flow
$ 9,168
-$6,800
$ 29,040
Add Depreciation
$ 60,720
$ 82,800
$ 27,600
Salvage Value
$ 72,000
Annual Cash Flow (Incremental net flow + Depreciation + salvage value)
$ 69,888
$ 76,000
$ 128,640
Year 1
Year 2
Year 3
Savings in Labour costs
$76,000
$ 76,000
$ 76,000
Less: Depreciaiton
$ 60,720
$ 82,800
$ 27,600
Incremental EBIT
$ 15,280
-$6,800
$ 48,400
Tax on incremental EBIT at 40%
$ 6,112
0
$ 19,360
Incremental net flow
$ 9,168
-$6,800
$ 29,040
Add Depreciation
$ 60,720
$ 82,800
$ 27,600
Salvage Value
$ 72,000
Annual Cash Flow (Incremental net flow + Depreciation + salvage value)
$ 69,888
$ 76,000
$ 128,640
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