You have been asked by the president of your company to evaluate the proposed acquisition of a new spectrometer for the firms’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 immediate 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?) * Price $70,000
Modification $15,000
Change in NWC $4,000
Net Cost $89,000 b. What are the net operating cash flows in Year 1, 2, and 3? * . Year 1 Year 2 Year 3
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

After-tax cost savings in $25,000(1-T) = $25,000(0.6) = $15,000
The depreciable basis, $85,000, times the MACRS allowance percentage of 0.33, 0.45, and 0.15 for Years 1, 2, and 3. The depreciation expense in Year 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.
I rounder the numbers for annual depreciation rates c. What is the additional (non-operating) cash flow in Year 3? * Salvage value $30,000
Tax on SV (9,620)
Return of NWC 4,000
Additional cash flow in Year 3 $24,380 d. If the project’s cost of capital is 10%, should the spectrometer be purchased? * With a financial calculator:
CF0 = -89,000 Year 0
CF1 = 26,220 Year 1
CF2 = 30,300 Year 2