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Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977

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BuyFindarrow_forward

Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977
Textbook Problem

NEW PROJECT ANALYSIS You must evaluate the purchase of a proposed spectrometer for the R&D department. The base price is $140,000, and it would cost another $30,000 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 $60.000. The applicable depreciation rates are 33%, 45%, 15%, and 7% as discussed in Appendix 12A. The equipment would require an $8,000 increase in net operating working capital (spare parts inventory). The project would have no effect on revenues, but it should save the firm $50,000 per year in before-tax labor costs. The firm’s marginal federal-plus-state tax rate is 40%.

  1. a. What is the initial investment outlay for the spectrometer, that is, what is the Year 0 project cash flow?
  2. b. What are the project’s annual cash flows in Years 1, 2, and 3?
  3. c. If the WACC is 12%, should the spectrometer be purchased? Explain.

a.

Summary Introduction

To compute: Initial investment outlay.

Initial Investment Outlay:

To start a business or a project, the company needs an amount, this amount is known as the initial investment outlay. It is also known as initial outlay. The amount of initial investment is calculated with the help of capital budgeting technique.

Modified accelerated cost recovery system (MACRS):

It is another method of calculating the depreciation. This method involves the tax element in the calculation. By this method, the fixed asset of the company is divided into sections and then depreciation is computed.

Net present Value (NPV):

NPV is the technique of capital budgeting. To choose whether to select or reject a project, it depends on the NPV of the project. If the project has positive NPV, then accept the project, if the NPV is negative, and then reject the project.

Explanation

Given,

Cost of spectrometer is $140,000.

Cost of modification is $30,000.

Working capital is $8,000.

Formula to calculate initial investment outlay is,

Initial investment outlay= (Cost of spectrometer+Cost of modification+Working capital)<

b.

Summary Introduction

To compute: The annual cash flows in first, second and third year.

c.

Summary Introduction

To explain: If the WACC is 12% the spectrometer is purchase.

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