Question

You must evaluate the purchase of a proposed spectrometer for the R&D department. The base price is $60,000, and it would cost another $12,000 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 $21,000. The applicable depreciation rates are 33%, 45%, 15%, and 7%. The equipment would require a $12,000 increase in net operating working capital (spare parts inventory). The project would have no effect on revenues, but it should save the firm $58,000 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. Negative amount should be indicated by a minus sign.
$

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 12%, should the spectrometer be purchased?

Answer 1

Answer: The initial investment outlay is $84,000.

Explanation:

Initial investment Outlay

= -60,000 - 12,000 - 12,000

= -$84,000

The project’s annual after-tax operating cash flows

Particulars Year 1

Revenues 0

operating Savings 58000

less Depreciation

(60000 + 12000) x 33%, - 23760

PBIT 34240

less Tax at 40% on PBIT - 13696

PAT 20544

Add Depreciation

(60000 + 12000) x 33% = 23760

Annual cash flows after tax = 44304

project’s annual after-tax operating cash flows

Particulars Year 2

Revenues 0

operating Savings 58000

less Depreciation

(60000 + 12000) x 45%,= 32400

PBIT 25600

lessTax at 40% on PBIT - 10240

PAT 15360

Add Depreciation

(60000 + 12000) x 45% = 32400

Annual cash flows after tax 47760

project’s annual after-tax operating cash flows

Particulars Year3

Revenues 0

operating Savings 58000

less Depreciation

(60000 + 12000) x 15% - 10800

PBIT 47200

less Tax at 40% on PBIT - 18880

PAT 28320

Add Depreciation

(60000 + 12000) x 15% 10800

Annual cash flows after tax = 39120