12-3 Net salvage value Kennedy Air Services is now in the final year of a project. The equip- ment originally cost $20 million, of which 80 percent has been depreciated. Kennedy can sell the used equipment today for $5 million, and its tax rate is 40 percent. What is the equipment's after-tax net salvage value? 12-4 Depreciation methods Kristin is evaluating a capital budgeting project that should last for 4 years. The project requires $800,000 of equipment. She is unsure what depreciation method to use in her analysis, straight-line or the 3-year MACRS accelerated method. Under straight-line depreciation, the cost of the equipment would be depreciated evenly over its 4-year life (ignore the half-year convention for the straight-line method). The applicable MACRS depreciation rates are 33, 45, 15, and 7 percent as discussed in Appendix 12A. The company's WACC is 10 percent, and its tax rate is 40 percent. a. What would the depreciation expense be each year under each method? b. Which depreciation method would produce the higher NPV, and how much higher would it be? 12-5 Scenario analysis Huang Industries is considering a proposed project whose estimated NPV is $12 million. This estimate assumes that economic conditions will be "average" However, the CFO realizes that conditions could be better or worse, so she performed a scenario analysis and obtained these results: Economic Scenario Recession Probability of Outcome NPV ($70 million) Below average Average: Above average Boom 0.05 0.20 0.50 0.20 0.05 (25 million) 12 million 20 million 30 million Calculate the project's expected NPV, standard deviation, and coefficient of variation. 12-6 New project analysis 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 percent 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 before-tax labor costs. 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 project cash flow? b. What are the net operating cash flows in Years 1, 2, and 3? c. What is the terminal cash flow? d. If the WACC is 12 percent, should the spectrometer be purchased? 12-7 New project analysis You must evaluate a proposal to buy a new milling machine. The base price is $108,000, and shipping and installation costs would add another $12,500. The machine falls into the MACRS 3-year class, and it would be sold after 3 years for $65,000. The applicable depreciation rates are 33, 45, 15, and 7 percent as discussed in Appendix 12A. The machine would require a $5,500 increase in working capital (increased inventory less increased accounts payable). There would be no effect on revenues, but pre-tax labor costs would decline by $44,000 per year. The marginal tax rate is 35 percent, and the WACC is 12 percent. Also, the firm spent $5,000 last year investigating the feasibility of using the machine. a. How should the $5,000 spent last year be handled? b. What is the net cost of the machine for capital budgeting purposes, that is, the Year 0 project cash flow? C. What are the net operating cash flows during Years 1, 2, and 3?