Question

Problem 13-6 New-Project Analysis The Campbell Company is considering adding a robotic paint sprayer to its production line. The sprayer's base price is $1,080,000, 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 $632,000. The MACRS rates for the first three years are 0.3333, 0.4445, 0.1481, and 0.0741. The machine would require an increase in net working capital (inventory) of $20,000. The sprayer would not change revenues, but it is expected to save the firm $399,000 per year in before-tax operating costs, mainly labor. Campbell's marginal tax rate is 35%. a. What is the Year-0 net cash flow? If the answer is negative, use minus sign. b. What are the net operating cash flows in Years 1, 2, and 3 Round your answers to the nearest dollar. 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)? Round your answer to the nearest dollar d. If the project's cost of capital is 15 %, what is the NPV of the project? Round your answer to the nearest dollar. Should the machine be purchased? -Select-

Answer 1

	(a)	Year 0 net Cash Flow:
	A	Basic Price	$1,080,000
	B	Installation cost	$20,500
	E=A+B	Depreciable Cost	$1,100,500
	C	Increase in net working capital	$20,000
	D=A+B+C	Year 0 net Cash Flow:	$1,120,500
	(b)	Net Operating Cash flow in Year 1,2,and 3
		Year	1	2	3	4
	A	Before tax savings	$             399,000	$        399,000	$        399,000
	B	Tax Rate	0.35	0.35	0.35
	C=A*(1-B)	After Tax Saving	$             259,350	$        259,350	$        259,350
	D	MACRS Recovery Rate	0.3333	0.4445	0.1481	0.0741
	E=1100500*D	Amount of depreciation	$             366,797	$        489,172	$        162,984	$          81,547
	F=E*B	Depreciation Tax Shield	$             128,379	$        171,210	$           57,044
	G=C+F	Net Operating cash flow	$             387,729	$        430,560	$        316,394
		Net Operating Cash flow in Year 1,2,and 3
		Year1	$             387,729
		Year2	$             430,560
		Year3	$             316,394
	.(c)	Additional year 3 Cash flow
	A	Book value of Equipment at end of year3	$                81,547
	B	Selling Price after 3 years	$632,000
	C=B-A	Gain on disposal	$550,453
	D=C*0.35	Taxes on Gain	$192,658.53
	E=B-D	Cash flow due to disposal	$439,341.47
	F	Release of Working Capital	$20,000
	G=E+F	Additional year 3 Cash flow	$459,341.47
	(d)	Calculation of Net Present Value(NPV)
	Present Value(PV) of Cash flow=(Cash Flow)/((1+i)^N)
		i=discount rate=cost of capital=15%=0.15
		N=Year of Cash flow
	Net Present Value (NPV)=Sum of PV of Cash flows
	N	Year	0	1	2	3
	A	Initial cash flow	($1,120,500)
	B	Net Operating cash flow		$        387,729	$        430,560	$        316,394
	C	Additional Cash flow end of year 3				$459,341.47
	D	Net Cash Flow	($1,120,500)	$        387,729	$        430,560	$        775,736	SUM
	E=D/(1.15^N)	Present Value of Cash Flows	$ (1,120,500.00)	$ 337,155.50	$ 325,565.43	$ 510,058.94	$ 52,279.87
		Sum of Present Values of Cash flows	$          52,279.87
		NPV of the project	$          52,279.87
		YES , The Machine should be Purchased
		NPV positive
		Hence, Rate of return is higher than cost of capital of 15%