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eBook Problem Walk-Through New-Project Analysis The Campbell Company is considering adding a robotic paint sprayer to its production line. The sprayer's base price is $1,090,000, and it would cost another $22,500 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 $627,000. The machine would require an increase in net working capital (inventory) of $16,500. The sprayer would not change revenues, but it is expected to save the firm $430,000 per year in before-tax operating costs, mainly labor. Campbell's marginal tax rate is 30%. 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 13 %, what is the NPV of the project? $   Should the machine be purchased? -Select-YesNo

Answer 1

Initial Investment = Base Price + Installation Cost
Initial Investment = $1,090,000 + $22,500
Initial Investment = $1,112,500

Useful Life = 3 years

Depreciation Year 1 = 33.33% * $1,112,500
Depreciation Year 1 = $370,796.25

Depreciation Year 2 = 44.45% * $1,112,500
Depreciation Year 2 = $494,506.25

Depreciation Year 3 = 14.81% * $1,112,500
Depreciation Year 3 = $164,761.25

Book Value at the end of Year 3 = $1,112,500 - $370,796.25 - $494,506.25 - $164,761.25
Book Value at the end of Year 3 = $82,436.25

After-tax Salvage Value = Salvage Value - (Salvage Value - Book Value) * tax rate
After-tax Salvage Value = $627,000 - ($627,000 - $82,436.25) * 0.30
After-tax Salvage Value = $463,630.875

Initial Investment in NWC = $16,500

Answer a.

Year 0:

Net Cash Flows = Initial Investment + Initial Investment in NWC
Net Cash Flows = -$1,112,500 - $16,500
Net Cash Flows = -$1,129,000

Answer b.

Year 1:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $430,000 * (1 - 0.30) + 0.30 * $370,796.25
Operating Cash Flow = $412,238.875 or $412,239

Year 2:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $430,000 * (1 - 0.30) + 0.30 * $494,506.25
Operating Cash Flow = $449,351.875 or $449,352

Year 3:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $430,000 * (1 - 0.30) + 0.30 * $164,761.25
Operating Cash Flow = $350,428.375 or $350,428

Answer c.

Additional Cash Flows = NWC recovered + After-tax Salvage Value
Additional Cash Flows = $16,500 + $463,630.875
Additional Cash Flows = $480,130.875 or $480,131

Answer d.

Cost of Capital = 13%

NPV = -$1,129,000 + $412,239/1.13 + $449,352/1.13^2 + $350,428/1.13^3 + $480,131/1.13^3
NPV = $163,341

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