You must evaluate the purchase of a spectrometer for the R&D department. The
base price is $140000 and it would cost another $30000 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 $60000. The applicable depreciation rates are 33%
45% 15% and 7% as discussed in Appendix 12A. The equipment would require an
$8000 increase in net operating working capital (spare parts inventory). The project
would have no effect on revenues but it should save the firm
$50000 per year in before-tax labor costs. The firm%u2019s marginal federal-plus-state tax
rate is 40%.
a. What is the initial investment outlay for the spectrometer that is what is the Year 0 project cash flow?
b. What are the project%u2019s annual cash flows in Years 1 2 and 3?
c. If the WACC is 12% should the spectrometer be purchased? Explain.
Cost of investment at t = 0:
Base price (140000)
Increase in NWC (8000)
Cash outlay for new machine (178000)
Annual cash flows:
Year 1 Year 2 Year 3
Depreciation tax savings
Tax on SV
Return of NWC
Project cash flows 0 0 0
Year Cash Flow PV