New-Project Analysis

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’s basic 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 $4,000. 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 rate is 40%.

a.
What is the net cost of the spectrometer? (That is, what is the Year-0 net cash flow?)

b.
What are the net operating cash flows in Years 1, 2, and 3?

c.
What is the additional (nonoperating) cash flow in Year 3?

d.
If the project’s cost of capital is 10%, should the spectrometer be purchased?

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