Question

The president of the company you work for has asked you to evaluate the proposed acquisition of a new chromatograph for the firm’s R&D department. The equipment's basic price is $190,000, and it would cost another $47,500 to modify it for special use by your firm. The chromatograph, which falls into the MACRS 3-year class, would be sold after 3 years for $47,500. The MACRS rates for the first three years are 0.3333, 0.4445, and 0.1481. Use of the equipment would require an increase in net working capital (spare parts inventory) of $9,500. The machine would have no effect on revenues, but it is expected to save the firm $76,000 per year in before-tax operating costs, mainly labor. The firm's marginal federal-plus-state tax rate is 30%.a. What is the Year-0 net cash flow?
b. What are the net operating cash flows in Years 1, 2, and 3?

Year 1 $
Year 2 $
Year 3 $
c. What is the additional (nonoperating) cash flow in Year 3?

d. If the project's cost of capital is 14%, should the chromatograph be purchased?

Answer 1

Answer:

Part A)

Year 0 net cash flow would comprise of basic price, modification cost and requirement for net working capital. The formula for cash flow in Year 0 would be:

Year 0 Net Cash Flow = -Basic Price - Modification Cost - NWC

______________

Using the values provided in the question, we get,

Year 0 Net Cash Flow = -190,000 - 47,500 - 9,500 = -$247,000

______________________

Part B:

Year 1, 2 and 3 would required adjustment for depreciation charges (under MACRS) against expected savings. The depreciation rates for 3 year class asset would be 33%, 45% and 15% for Year 1, Year 2 and Year 3 respectively.

Depreciation would be calculated on the equipment's basic price and modification cost.

The formula that can be used to calculate the net operating cash flow would be:

Net Operating Cash Flow = (Sales - Depreciation)*(1-Tax Rate) + Depreciation

______________

Using the values provided in the question, we get, the table in the attached file

Important Information:

Depreciation (Year 1) = (190,000 + 47,500)*33% = $78,375

Depreciation (Year 2) = (190,000 + 47,500)*45% = $106,875

Depreciation (Year 3) = (190,000 + 47,500)*15% = $35,625

______________________

Part C:

Additional non operating cash flow would consist of after-tax salvage value and return of net working capital. Relevant formulas are:

Additional Non Operating Cash Flow = After Tax Salvage Value + Return of Net Working Capital

After Tax Salvage Value = Sales Value +/- Tax on Loss/Gain from Sale of Asset

Loss/Gain from Sale of Asset = Sales Value - Book Value

Book Value = (Basic Price + Modification Cost)*(1-(33%+45%+15%))

______________

Using the above mentioned formulas, we get,

Book Value = (190000 + 47500)*(1-(33%+45%+15%)) = $16,625

Gain on Sale of Equipment = 66,500 - 16,625 = $49,875

Tax on Gain = $49,875*30% = $14,962.50

After Tax Salvage Value = 66,500 - 14,962.50 = $51,537.50

_____________________

Additional (Non Operating) Cash Flow = $51,537.50 + $9,500 = $61,037.50 or $61,038

Explanation: