4)



4)

You have been asked by the president of your company to evaluate the proposed acquisition of a new spectrometer for th efirm's R&D department. The equipments basic price is 70000 and it would cost another 15000 to modify it for special use by your firm. The spectrometer, which falls into the MACRS 3 year class would be sold after 3years for 30000. Use the equipment would require an increase in net working capital(spare parts inventory) of 4000. The spectrometer would have no effect on revenues but it is expected to save the firm 25000 per year in before tax operating costs mainly labor. The firms marginal federal plus state tax rate is 40%

a. what is the net cost of the spectrometer that is the year 0 nat cash flow?

b. what are the net operating cash flows in year 1,2,3

c what is the additional nonoperating cash flow in year 3?

D if the projects cost of capital is 10 %, should the spectrometer be purchased?

a.

Price ($70,000)

Modification (15,000)

Change in NWC (4,000)

Net Cost ($89,000)

b.

Year 1 Year 2 Year 3

*After-tax savings $15,000 $15,000 $15,000

**Depreciation shield 11,220 15,300 5,100

Operating cash flow $26,220 $30,300 $20,100

* The after-tax cost savings is $25,000(1 – T) = $25,000(0.6)

= $15,000.

**The depreciation expense in each year is the depreciable basis, $85,000, times the MACRS allowance percentage of 0.33, 0.45, and 0.15 for Years 1, 2 and 3, respectively. Depreciation expense in Years 1, 2, and 3 is $28,050, $38,250, and $12,750. The depreciation shield is calculated as the tax rate (40%) times the depreciation expense in each year.

c.

Salvage value $30,000

Tax on SV* (9,620)

Return of NWC 4,000

Additional end-of-project cash flow $24,380

*Tax on SV = ($30,000 - $5,950)(0.4) = $9,620.

The remaining Book Value in Year 4 = $85,000(0.07) = $5,950.

d.

|Year |Cash Fow |

|0 |($89,000) |

|1 |$26,220 |

|2 |$30,300 |

|3 |$44,480 |

|  |  |

|NPV |($6,703.83) |

The project has a negative NPV, therefore it should not be accepted

Alternatively, with a financial calculator, input the following: CF0 = -89000, CF1 = 26220, CF2 = 30300, CF3 = 44480, and I = 10 to solve for NPV = -$6,703.83.

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