Week 5 project
Problem 11- 7
You have been asked by the president of your company to evaluate the proposed acquisition of a new spectrometer for the firm’s R&D department. The equipment’s basic price is $70,000, and it would cost another $15,000 to modify it for special use by your firm. The spectrometer, which falls into the MACRS 3-year class, would be sold after 3 years for $30,000. Use of the equipment would require an increase in net working capital (spare parts inventory) of $4,000. The spectrometer would have no effect on revenues, but it is expected to save the firm $25,000 per year in before-tax operating costs, mainly labor. The firm’s marginal federal-plus-state tax rate is 40%.
a. What is the net cost of the spectrometer? (That is, what is the Year-0 net cash flow?)
b. What are the net operating cash flows in Years 1, 2, and 3? (26220,30300,20100)
c. What is the additional (nonoperating) cash flow in Year 3? 24380
d. If the project’s cost of capital is 10%, should the spectrometer be purchased? NPV=-6704 no purchase
Spectrometer Base Price: $70,000
Salvage after 3 years: $30000
Net work Capital Increase: $4000
Cost savings before Taxes: $25000/year
Marginal Fed and State tax rate: 40%
a. What is the net cost of the spectrometer?
Spectrometer Base Price: | - $70,000 |
Modifications: | - $15,000 |
Net work Capital Increase: | - $4,000 |
Total Net cash flow: | -$89,000 |
b. What are the net operating cash flows in Years 1, 2, and 3?
After Tax = (25,000 * (1-0.40) = $15,000/year
MARC 3-year Deprecation Rate = 33%, 45%, 15%, 7%
c. What is the additional (non operating) cash flow in Year 3?
d. If the project’s cost of capital is 10%, should the spectrometer be purchased?
Since the NPV is negative, reject the project