Question

You must evaluate the purchase of a proposed spectrometer for the R&D department. The purchase price of the spectrometer including modifications is $120,000, and the equipment will be fully depreciated at the time of purchase. The equipment would be sold after 3 years for $41,000. 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 $34,000 per year in before-tax labor costs. The firm's marginal federal-plus-state tax rate is 25%.

1. What is the initial investment outlay for the spectrometer, that is, what is the Year 0 project cash flow? Enter your answer as a positive value. Round your answer to the nearest dollar.
   $  
2. 
   
3. What are the project's annual cash flows in Years 1, 2, and 3? Do not round intermediate calculations. Round your answers to the nearest dollar.
   Year 1: $  
   Year 2: $  
   Year 3: $  
4. 
   
5. If the WACC is 11%, should the spectrometer be purchased?
   -Select-Yes or No

Answer 1

Time line		0	1	2	3
Cost of new machine		-120000
Initial working capital		-12000
=a. Initial Investment outlay		-132000
						100.00%
Savings			34000	34000	34000
-Depreciation	Cost of equipment/no. of years		-40000	-40000	-40000	0	=Salvage Value
=Pretax cash flows			-6000	-6000	-6000
-taxes	=(Pretax cash flows)*(1-tax)		-4500	-4500	-4500
+Depreciation			40000	40000	40000
=after tax operating cash flow			35500	35500	35500
reversal of working capital					12000
+Proceeds from sale of equipment after tax	=selling price* ( 1 -tax rate)				30750
+Tax shield on salvage book value	=Salvage value * tax rate				0
=Terminal year after tax cash flows					42750
b. Total Cash flow for the period		-132000	35500	35500	78250
Discount factor=	(1+discount rate)^corresponding period	1	1.11	1.2321	1.367631
Discounted CF=	Cashflow/discount factor	-132000	31981.98198	28812.59638	57215.72559
c. NPV=	Sum of discounted CF=	-13989.70

Donot purchase as NPV is negative