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’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 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 year 1, 2, and 3?

C.      C. What is the additional non-operating cash flow in year 3?

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