Fi515 Week 5 Project
(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 rate is 40%. a. What is the net cost of the spectrometer? (That is, what is the Year-0 net cash flow?)
The net cost is -$89,000: Price = ($70,000) Modification = (15,000) Change in NWC = (4,000) ($89,000) =======
(Brigham/Erhardt; p.385) “Projects generally require an initial investment—for example, developing the product, buying the equipment needed to make it, building a factory, and stocking inventory. The initial investment is a negative cash flow”. b. What are the net operating cash flows in Years 1, 2, and 3?
The operating cash flows are as follows: 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 ====================
Notes:
1. The after-tax cost savings is $25,000(1-T)=$25,000(.6)=$15,000. 2. The depreciation expense in each year is the depreciable basis, $85,000 times the MACRS allowance percentage of .33, .45, and .15 for Years 1, 2, and 3. Depreciation expense in Years 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 each year.
3. I rounded the numbers for annual depreciation
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?)
The net cost is -$89,000: Price = ($70,000) Modification = (15,000) Change in NWC = (4,000) ($89,000) =======
(Brigham/Erhardt; p.385) “Projects generally require an initial investment—for example, developing the product, buying the equipment needed to make it, building a factory, and stocking inventory. The initial investment is a negative cash flow”. b. What are the net operating cash flows in Years 1, 2, and 3?
The operating cash flows are as follows: 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 ====================
Notes:
1. The after-tax cost savings is $25,000(1-T)=$25,000(.6)=$15,000. 2. The depreciation expense in each year is the depreciable basis, $85,000 times the MACRS allowance percentage of .33, .45, and .15 for Years 1, 2, and 3. Depreciation expense in Years 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 each year.
3. I rounded the numbers for annual depreciation