Question

The Campbell Company is considering adding a robotic paint sprayer to its production line. The sprayer's base price is $990,000, and it would cost another $24,500 to install it. The machine falls into the MACRS 3-year class, and it would be sold after 3 years for $575,000. 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 $12,000. The sprayer would not change revenues, but it is expected to save the firm $305,000 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.

A. What is the Year-0 net cash flow?

B. What are the net operating cash flows in Years 1, 2, and 3?

Year 1: $______

Year 2: $______

Year 3: $______

C: What is the additional Year-3 cash flow (i.e, the after-tax salvage and the return of working capital)?

D. If the project's cost of capital is 10%, what is the NPV of the project?

E. Should the machine be purchased? Yes or no?

Answer 1

Initial Investment = Base Price + Modification Cost
Initial Investment = $990,000 + $24,500
Initial Investment = $1,014,500

Useful Life = 3 years

Depreciation Year 1 = 0.3333 * $1,014,500
Depreciation Year 1 = $338,132.85

Depreciation Year 2 = 0.4445 * $1,014,500
Depreciation Year 2 = $450,945.25

Depreciation Year 3 = 0.1481 * $1,014,500
Depreciation Year 3 = $150,247.45

Book Value at the end of Year 3 = $1,014,500.00 - $338,132.85 - $450,945.25 - $150,247.45
Book Value at the end of Year 3 = $75,174.45

After-tax Salvage Value = Salvage Value - (Salvage Value - Book Value) * tax rate
After-tax Salvage Value = $575,000 - ($575,000 - $75,174.45) * 0.25
After-tax Salvage Value = $450,044

Initial Investment in NWC = $12,000

Answer a.

Year 0:

Net Cash Flows = Initial Investment + Initial Investment in NWC
Net Cash Flows = -$1,014,500 - $12,000
Net Cash Flows = -$1,026,500

Answer b.

Year 1:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $305,000 * (1 - 0.25) + 0.25 * $338,132.85
Operating Cash Flow = $313,283

Year 2:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $305,000 * (1 - 0.25) + 0.25 * $450,945.25
Operating Cash Flow = $341,486

Year 3:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $305,000 * (1 - 0.25) + 0.25 * $150,247.45
Operating Cash Flow = $266,312

Answer c.

Additional Cash Flows = NWC recovered + After-tax Salvage Value
Additional Cash Flows = $12,000 + $450,044
Additional Cash Flows = $462,044

Answer d.

Required Return = 10%

NPV = -$1,026,500 + $313,283/1.10 + $341,486/1.10^2 + $266,312/1.10^3 + $462,044/1.10^3
NPV = $87,747

Answer e.

NPV of the machine is positive. So, you should purchase the machine.