Question

You must evaluate the purchase of a proposed spectrometer for the R&D department. The base price is $160,000, and it would cost another $40,000 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 $80,000. The applicable depreciation rates are 33%, 45%, 15%, and 7%. The equipment would require a $7,000 increase in net operating working capital (spare parts inventory). The project would have no effect on revenues, but it should save the firm $52,000 per year in before-tax labor costs. The firm's marginal federal-plus-state tax rate is 40%.

Required:
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's annual cash flows in Years 1, 2, and 3?

Answer 1

a.

$207,000

b.

Year 1: $57,600

Year 2: $67,200

Year 3: $30,000

Step-by-step explanation:

a.

Calculate the initial outlay of the project at year 0 as follow

Initial Outlay = Base Price + Modification cost + Working Capital requirement

Initial Outlay = $160,000 + $40,000 + $7,000

Initial Outlay = $207,000

b.

The working for the calculation of the cash flow is attached with this answer, please refer to the attached file.