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 $230,000, and it would cost another $46,000 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 $69,000. 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 $21,000 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 $

If the WACC is 14%, should the spectrometer be purchased?

Explanation / Answer

Year 0 Cash Flow = $230,000 + $46,000 + $11,000 = $287,000

Cash Inflow = After-tax savings + Depreciation + Recovery of NWC (In 3rd Year) + After-tax salvage value of machine (In 3rd Year)

Year 1 = $21,000*(1-0.4) + $75,900 = $88,500
Year 2 = $21,000*(1-0.4) + $103,500 = $116,100
Year 3 = $21,000*(1-0.4) + $34,500 + $11,000 + $69,000*(1-t) = $99,500

NPV = -$287,000 + [($88,500)/(1.14)] + [($116,100)/(1.14)2] + [($99,500)/(1.14)3] =-$52,873.57

Since at 14% WACC, the NPV is negative, the spectrometer should not be purchased.

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