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You must evaluate 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 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%.
a. What is the net cost of the spectrometer; that is, what is the Year 0 project cash flow?
b. What are the project’s annual net cash flows in Years 1, 2, and 3?
c. If the WACC is 12%, should the spectrometer be purchased? Explain.
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