You must evaluate the purchase of a proposed spectrometer for the R&D department. The base price...

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You must evaluate the purchase of a proposed spectrometer forthe R&D department. The base price is $280,000, and it wouldcost another $70,000 to modify the equipment for special use by thefirm. The equipment falls into the MACRS 3-year class and would besold after 3 years for $70,000. The applicable depreciation ratesare 33%, 45%, 15%, and 7%. The equipment would require a $7,000increase in net operating working capital (spare parts inventory).The project would have no effect on revenues, but it should savethe firm $21,000 per year in before-tax labor costs. The firm'smarginal 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 tothe nearest cent. Negative amount should be indicated by a minussign.
$
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 10%, should the spectrometer be purchased?
yes or no

Answer & Explanation Solved by verified expert

3.9 Ratings (564 Votes)

Time line		0	1	2	3



Cost of new machine		-350000
Initial working capital		-7000
=a. Initial Investment outlay		-357000

3 years MACR rate			33.00%	45.00%	15.00%	7.00%

Savings			21000	21000	21000


-Depreciation	=Cost of machine*MACR%		-115500	-157500	-52500	24500	=Salvage Value

=Pretax cash flows			-94500	-136500	-31500
-taxes	=(Pretax cash flows)*(1-tax)		-56700	-81900	-18900
+Depreciation			115500	157500	52500
=after tax operating cash flow			58800	75600	33600

reversal of working capital					7000

+Proceeds from sale of equipment after tax	=selling price* ( 1 -tax rate)				42000
+Tax shield on salvage book value	=Salvage value * tax rate				9800
=Terminal year after tax cash flows					58800

b.Total Cash flow for the period		-357000	58800	75600	92400
Discount factor=	(1+discount rate)^corresponding period	1	1.1	1.21	1.331
Discounted CF=	Cashflow/discount factor	-357000	53454.55	62479.34	69421.488
c. NPV=	Sum of discounted CF=	-171644.63

Reject as NPV is negative

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Transcribed Image Text

You must evaluate the purchase of a proposed spectrometer forthe R&D department. The base price is $280,000, and it wouldcost another $70,000 to modify the equipment for special use by thefirm. The equipment falls into the MACRS 3-year class and would besold after 3 years for $70,000. The applicable depreciation ratesare 33%, 45%, 15%, and 7%. The equipment would require a $7,000increase in net operating working capital (spare parts inventory).The project would have no effect on revenues, but it should savethe firm $21,000 per year in before-tax labor costs. The firm'smarginal federal-plus-state tax rate is 40%.What is the initial investment outlay for the spectrometer,that is, what is the Year 0 project cash flow? Round your answer tothe nearest cent. Negative amount should be indicated by a minussign.$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 10%, should the spectrometer be purchased?yes or no