Question

The Campbell Company is considering adding a robotic paint sprayer to its production line. The sprayer's base price is $870,000, and it would cost another $20,000 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 $566,000. The machine would require an increase in net working capital (inventory) of $18,500. The sprayer would not change revenues, but it is expected to save the firm $392,000 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.

1. What is the Year-0 net cash flow?

   $   

2. What are the net operating cash flows in Years 1, 2, and 3?

   Year 1:	$
   Year 2:	$
   Year 3:	$

3. What is the additional Year 3 cash flow (i.e, the after-tax salvage and the return of working capital)?

   $   

4. If the project's cost of capital is 10 %, what is the NPV of the project?

   $   

   Should the machine be purchased?

Answer 1

a.Initial Investment Outlay = Base Price + Modification cost + Increase in Working Capital

= 870,000+20,000 +18,500

= -$908,500 since outflow

b.Operating Cash Flows:

	Year 1	2	3
Savings in Cost	392,000	392,000	392,000
Less: Depreciation	296,637	395,605	131,809
Net Savings	95,363	-3,605	260,191
Less: Tax @30%	28,608.90	-1,081.50	78,057.30
Income after Tax	66,754.10	-2,523.50	182,133.70
Add: Depreciation	296,637	395,605	131,809
Cash Flow	363,391.10	393,081.50	313,942.70

3.Additional Cash flow:

Note: Written down value of machine = 890,000*7.41% = $65,949

Sale Price = $566,000

Gain on Sale = $500,051

Tax on Gain = $150,015.3

After tax salvage value =566,000– 150,015.3= $415,984.7

Recovery of Working Capital = $18,500

Additional Cash flow = $434,484.7

c.NPV = Present value of cash inflows – present value of cash outflows

= 363,391.10*PVF(10%, 1 year) + 393,081.50*PVF(10%, 2 years) + 748,427.4*PVF(10%, 3 years) – 908,500

= 363,391.10*0.909 + 393,081.50*0.826+ 748,427.4*0.751 – 908,500

= $308,576.81

Yes, should be purchased (since NPV is positive)