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    New Project Analysis: Capital Budgeting

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    You have been asked 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 the 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 specotrometer would have no effect on revenue, 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 percent.

    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 Years 1, 2, and 3?
    c. What is the additional cash flow in Year 3?
    d. If the project's cost of capital is 10 percent, should the spectrometer be purchased?

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    Solution Preview

    a. What is the net cost of the spectrometer? (That is, what is the Year 0 net cash flow?)

    The net cost of the spectrometer is the purchase price and any other cost needed to make it working. The cost of the spectrometer will be $70,000+$15,000=$85,000.
    In the year 0 there will also be investment in the working ...

    Solution Summary

    The response consists of 171 words and includes an attached Excel file.