Question

New-Project Analysis The Campbell Company is considering adding a robotic paint sprayer to its production line. The sprayer's base price is $1,040,000, and it would cost another $20,500 to install it. The machine falls into the MACRS 3-year class, and it would be sold after 3 years for $535,000. The MACRS rates for the first three years are 0.3333, 0.4445, and 0.1481. The machine would require an increase in net working capital (inventory) of $13,000. The sprayer would not change revenues, but it is expected to save the firm $325,000 per year in before-tax operating costs, mainly labor. Campbell's marginal tax rate is 25%. (Ignore the half-year convention for the straight-line method.) Cash outflows, if any, should be indicated by a minus sign. Do not round intermediate calculations. Round your answers to the nearest dollar. What is the Year-0 net cash flow? $ What are the net operating cash flows in Years 1, 2, and 3? Year 1: $ Year 2: $ Year 3: $ What is the additional Year-3 cash flow (i.e, the after-tax salvage and the return of working capital)? $ If the project's cost of capital is 10%, what is the NPV of the project? $ Should the machine be purchased?

Answer 1

Answer:

Initial Investment = Base Price + Installation Cost
Initial Investment = $1,040,000 + $20,500
Initial Investment = $1,060,500

Useful Life = 3 years

Depreciation Year 1 = 0.3333 * $1,060,500
Depreciation Year 1 = $353,464.65

Depreciation Year 2 = 0.4445 * $1,060,500
Depreciation Year 2 = $471,392.25

Depreciation Year 3 = 0.1481 * $1,060,500
Depreciation Year 3 = $157,060.05

Book Value at the end of Year 3 = $1,060,500.00 - $353,464.65 - $471,392.25 - $157,060.05
Book Value at the end of Year 3 = $78,583.05

After-tax Salvage Value = Salvage Value - (Salvage Value - Book Value) * tax rate
After-tax Salvage Value = $535,000.00 - ($535,000.00 - $78,583.05) * 0.25
After-tax Salvage Value = $420,895.76

Initial Investment in NWC = $13,000

Year 0:

Net Cash Flows = Initial Investment + Initial Investment in NWC
Net Cash Flows = -$1,060,500 - $13,000
Net Cash Flows = -$1,073,500

Year 1:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $325,000 * (1 - 0.25) + 0.25 * $353,464.65
Operating Cash Flow = $332,116.16

Year 2:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $325,000 * (1 - 0.25) + 0.25 * $471,392.25
Operating Cash Flow = $361,598.06

Year 3:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $325,000 * (1 - 0.25) + 0.25 * $157,060.05
Operating Cash Flow = $283,015.01

Additional Cash Flows = NWC recovered + After-tax Salvage Value
Additional Cash Flows = $13,000.00 + $420,895.76
Additional Cash Flows = $433,895.76

Required Return = 10%

NPV = -$1,073,500 + $332,116.16/1.10 + $361,598.06/1.10^2 + $283,015.01/1.10^3 + $433,895.76/1.10^3
NPV = $65,890.83

NPV of the project is positive, therefore, the machine should be purchased