11-7 New-Project Analysis
You have been asked by the president of your company to evaluate the proposed acquisition of a new spectrometer for the firm’s R+D Department. The equipment price is $70,000 and it would cost another $15,000 to modify it for special use by your firm. The spectrometer which falls into the MACRS 3-year class would be sold after 3 years for $30,000. Use of 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 $25,000 per year in before tax operating costs mainly labor. The firm’s marginal federal – plus. State tax is 40%.
A) What is the net cost of the spectrometer?
Information was given the equipment base price, modification for use cost and working capital for use $70,000.00 + $15,000.00 + 4,000.00 = $89,000.00. The 89,000 is negative since it is the cost of the equipment and all associated costs to bring into operation.
The answer is negative $89,000.
B) What are the net operating cash flows in years 1, 2, 3?
Year 1 year 2 year3
After –tax savings $15,000 $15,000 $15,000
Depreciation shield $11,220 $15,300 $ 5,100
Net- cash Flow $26,220 $30,300 $20,100
C) What is the additional (non- operating) cash flow in year 3?
Salvage value + net working capital recovery –tax on salvage value
30,000 + 4,000 – 9620 = $24,380.00 Cash flow year 3 is $24,380.00
D) If the project cost of capital is 10% should the spectrometer be purchased?
Calculated with financial calculator CFo = -89000, CF1 = 26220, CF2 = 30,300 CF3 = 4480 and I/YR = 10 solve for NPV = -$6703.83.
NPV = -$6704 and should not be purchase.