Problem:
You have been asked by the president of your company to evaluate the proposed acquisition of a new hydropropolaser for the R&D department. The price for this equipment is $70,000, and it would cost another $14,000 to modify it for special use by your firm. The hydropropolaser, which has a MACRS 3-year recovery period (wts. 33%, 45%, 15%, 7%) would be sold after 3 years for $30,000. Use of this equipment would require an increase in net working capital of $11,000. The hydropropolaser would have no effect on revenues, but it is expected to save the firm $20,000 per year in before-tax operating costs, mainly labor. The firm’s marginal tax rate is 36%.
Question 1. What is the initial net investment for the machine (CF0)?
Price of machine $70,000.00
modification $14,000.00
increase in net working capital $11,000.00
Initial Net Investment for machine $95,000.00
Question 2. What are the net operating cash flows from this project for years 1 –3?
| First have to depreciate |
|
|
|
|
|
| YR |
Depre Basis |
Weight |
Formula |
Tax Savings |
Relevant Cash Flows |
| CF0 |
84,000 |
|
|
|
|
| CF1 |
84,000 |
33 |
.33*(84000)*(.36) |
$9,979.20 |
? |
| CF2 |
84,000 |
45 |
.45*(84000)*(.36) |
$13,608.00 |
? |
| CF3 |
84,000 |
15 |
.15*(84000)*(.36) |
$4,536.00 |
? |
| CF4 |
84,000 |
7 |
.07*(84000)*(.36) |
$2,116.80 |
? |
| Relevant CasH Flows-tax benefits + depreciation savings |
|
|
|
|
Relevant Cash Flows |
Tax Savings |
|
Depreciation Savings |
|
| 1 |
|
$9,979.20 |
.33*(84000) |
$27,720.00 |
|
| 2 |
? |
$13,608.00 |
.45*(84000) |
$37,800.00 |
|
| 3 |
? |
$4,536.00 |
.15*(84000) |
$12,600.00 |
|
| 4 |
? |
$2,116.80 |
.07*(84000) |
$5,880.00 |
|
Question 3. What are the additional cash flows from this project in year 3?
Question 4. If the firm’s WACC is 14%, should they purchase the hydrpropolaser?