Question

The Campbell Company is considering adding a robotic paint sprayer to its production line. The sprayer's base price is $840,000, and it would cost another $16,000 to install it. The machine falls into the MACRS 3-year class, and it would be sold after 3 years for $642,000. 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 $16,000. The sprayer would not change revenues, but it is expected to save the firm $334,000 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-O 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 (ie, the after-tax salvage and the return of working capital)? d. If the project's cost of capital is 11%, what is the NPV of the project? Should the machine be purchased? -Select-

Answer 1

Initial Investment = Base Price + Installation Cost
Initial Investment = $840,000 + $16,000
Initial Investment = $856,000

Useful Life = 3 years

Depreciation Year 1 = 0.3333 * $856,000
Depreciation Year 1 = $285,304.80

Depreciation Year 2 = 0.4445 * $856,000
Depreciation Year 2 = $380,492.00

Depreciation Year 3 = 0.1481 * $856,000
Depreciation Year 3 = $126,773.60

Book Value at the end of Year 3 = $856,000 - $285,304.80 - $380,492 - $126,773.60
Book Value at the end of Year 3 = $63,429.60

After-tax Salvage Value = Salvage Value - (Salvage Value - Book Value) * tax rate
After-tax Salvage Value = $642,000 - ($642,000 - $63,429.60) * 0.25
After-tax Salvage Value = $497,357

Initial Investment in NWC = $16,000

Answer a.

Year 0:

Net Cash Flows = Initial Investment + Initial Investment in NWC
Net Cash Flows = -$856,000 - $16,000
Net Cash Flows = -$872,000

Answer b.

Year 1:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $334,000 * (1 - 0.25) + 0.25 * $285,304.80
Operating Cash Flow = $321,826

Year 2:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $334,000 * (1 - 0.25) + 0.25 * $380,492
Operating Cash Flow = $345,623

Year 3:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $334,000 * (1 - 0.25) + 0.25 * $126,773.60
Operating Cash Flow = $282,193

Answer c.

Year 3:

Additional Cash Flows = NWC recovered + After-tax Salvage Value
Additional Cash Flows = $16,000 + $497,357
Additional Cash Flows = $513,357

Answer d.

Cost of Capital = 11%

NPV = -$872,000 + $321,826/1.11 + $345,623/1.11^2 + $282,193/1.11^3 + $513,357/1.11^3
NPV = $280,148

NPV of the project is positive. So, the machine should be purchased.