Question

New-Project Analysis The Campbell Company is considering adding a robotic paint sprayer to its production line. The sprayer's base price is $810,000, and it would cost another $23,000 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 $628,000. The machine would require an increase in net working capital (inventory) of $19,500. The sprayer would not change revenues, but it is expected to save the firm $459,000 per year in before-tax operating costs, mainly labor. Campbell's marginal tax rate is 40%. 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 11 %, what is the NPV of the project? $ Should the machine be purchased?

Answer 1

Initial Investment = Base Price + Installation Cost
Initial Investment = $810,000 + $23,000
Initial Investment = $833,000

Useful Life = 3 years

Depreciation Year 1 = 33.33% * $833,000
Depreciation Year 1 = $277,638.90

Depreciation Year 2 = 44.45% * $833,000
Depreciation Year 2 = $370,268.50

Depreciation Year 3 = 14.81% * $833,000
Depreciation Year 3 = $123,367.30

Book Value at the end of Year 3 = $833,000 - $277,638.90 - $370,268.50 - $123,367.30
Book Value at the end of Year 3 = $61,725.30

After-tax Salvage Value = Salvage Value - (Salvage Value - Book Value) * tax rate
After-tax Salvage Value = $628,000 - ($628,000 - $61,725.30) * 0.40
After-tax Salvage Value = $401,490.12

Initial Investment in NWC = $19,500

Year 0:

Net Cash Flows = Initial Investment + Initial Investment in NWC
Net Cash Flows = -$833,000 - $19,500
Net Cash Flows = -$852,500

Year 1:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $459,000 * (1 - 0.40) + 0.40 * $277,638.90
Operating Cash Flow = $386,455.56

Year 2:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $459,000 * (1 - 0.40) + 0.40 * $370,268.50
Operating Cash Flow = $423,507.40

Year 3:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $459,000 * (1 - 0.40) + 0.40 * $123,367.30
Operating Cash Flow = $324,746.92

Additional Cash Flows = NWC recovered + After-tax Salvage Value
Additional Cash Flows = $19,500 + $401,490.12
Additional Cash Flows = $420,990.12

Required Return = 11%

NPV = -$852,500 + $386,455.56/1.11 + $423,507.40/1.11^2 + $324,746.92/1.11^3 + $420,990.12/1.11^3
NPV = $384,662.77

Yes, the machine should be purchased.