Capital Budgeting:
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 base price is $75,000 and it would cost another $15,000 to install it. The spectrometer falls under 3-year MACRS schedule and will be sold after 3 years for $30,000. Use of the equipment will require an increase in net working capital of $4,000 in year 0. The net working capital will be fully recovered or returned when the project is terminated at the end of year 3. The project is expected to generated Earnings Before Taxes and Depreciation (EBTD) of $25,000 per year. Assume the firm's tax rate is 40%. {Note 3-year MACRS tax rates are =.33; .45; .15 and .07 percent in years 1-4; you may recall that due to half-year convention 3-year rule leads to depreciation for 4 years)
(a) What is the cash flow in year 0?
(b) What is the cash flow in years 1, 2, 3?
(c) If the cost of financing this project is 10%, should the project be accepted using NPV or IRR?
(d) How does depreciation expense influence the results in part (c) even though depreciation is a non-cash expense?