Question

The Campbell Company is considering adding a robotic paint sprayer to its production line. The sprayer's base price is $1,200,000, and it would cost another $21,000 to install it. The machine falls into the MACRS 3-year class (the applicable MACRS depreciation rates are 33.33%, 44.45%, 14.81%, and 7.41%), and it would be sold after 3 years for $578,000. The machine would require an increase in net working capital (inventory) of $12,500. The sprayer would not change revenues, but it is expected to save the firm $407,000 per year in before tax operating costs, mainly labor. Campbell's marginal tax rate is 40%. a. What is the Year 0 net cash flow? b. What are the net operating cash flows in Years 1, 2, and 37 Do not round Intermediate calculations. Round your answers to the nearest dollar Year 1 Year 2 Year 3 c. What is the additional Year 3 cash flow (le, the after-tax salvage and the return of working capital)? Do not round intermediate calculations. Round your answer to the nearest dollar. d. If the project's cost of capital is 12%, what is the NPV of the project? Do not round intermediate calculations. Round your answer to the nearest dollar Should the machine be purchased?

Answer 1

Initial Investment = Base Price + Installation Cost
Initial Investment = $1,200,000 + $21,000
Initial Investment = $1,221,000

Useful Life = 3 years

Depreciation Year 1 = 33.33% * $1,221,000
Depreciation Year 1 = $406,959.30

Depreciation Year 2 = 44.45% * $1,221,000
Depreciation Year 2 = $542,734.50

Depreciation Year 3 = 14.81% * $1,221,000
Depreciation Year 3 = $180,830.10

Book Value at the end of Year 3 = $1,221,000 - $406,959.30 - $542,734.50 - $180,830.10
Book Value at the end of Year 3 = $90,476.10

After-tax Salvage Value = Salvage Value - (Salvage Value - Book Value) * tax rate
After-tax Salvage Value = $578,000 - ($578,000 - $90,476.10) * 0.40
After-tax Salvage Value = $382,990.44

Initial Investment in NWC = $12,500

Answer a.

Year 0:

Net Cash Flows = Initial Investment + Initial Investment in NWC
Net Cash Flows = -$1,221,000 - $12,500
Net Cash Flows = -$1,233,500

Answer b.

Year 1:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $407,000 * (1 - 0.40) + 0.40 * $406,959.30
Operating Cash Flow = $406,984

Year 2:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $407,000 * (1 - 0.40) + 0.40 * $542,734.50
Operating Cash Flow = $461,294

Year 3:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $407,000 * (1 - 0.40) + 0.40 * $180,830.10
Operating Cash Flow = $316,532

Answer c.

Additional Cash Flows = NWC recovered + After-tax Salvage Value
Additional Cash Flows = $12,500 + $382,990.44
Additional Cash Flows = $395,490

Answer d.

Required Return = 12%

NPV = -$1,233,500 + $406,984/1.12 + $461,294/1.12^2 + $316,532/1.12^3 + $395,490/1.12^3
NPV = $4,423

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