Question

The Reynold Company is considering adding a robotic paint sprayer to its production line. The sprayer’s base price is $1,200,000, and it would cost another $18,500 to install it. The machine falls into the MACRS 3-year class, and it would be sold after 3 years for $770,000. The MACRS rates for the first 3 years are 0.3333, 0.4445, and 0.1481. 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 $420,000 per year in before-tax operating costs, mainly labor. Campbell’s marginal tax rate is 28%. Find the initial investment outlay, the annual depreciation, the yearly operating cash flow, the terminal cash flow, and decide whether the firm should accept the project.

CAN YOU SHOW STEPS

Answer 1

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Initial Investment Outlay = -$1,238,000

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Annual Depreciation:

Year 1 = $406,125.05

Year 2 = $541,623.25

Year 3 = $180,459.85

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Terminal Cash Flow

Terminal Cash Flow is $599,181.44

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Calculation of NPV of the Project
Particulars	0	1	2	3
Initial Investment
Sprayer's base price	-1200000
Installation cost	-18500
Investment in working capital	-19500
Net Initial Investment (A)	-1238000
Operating Cash Flows
Saving in Before Tax Operating profits (B)		420000	420000	420000
Less: Depreciation (C ) ($1,218,500 * 0.3333,0.4445,0.1481)		406126.05	541623.25	180459.85
Profit before tax (D = B-C)		13873.95	-121623.25	239540.15
Less: Tax @28% (E = C-D)		3884.706	-34054.51	67071.242
Profit After Tax (F = D-E)		9989.244	-87568.74	172468.908
Add back Depreciation (G = C)		406126.05	541623.25	180459.85
Net Operating Cash Flows (H = F+G)		416115.29	454054.51	352928.758
Terminal Value
Sale value of sprayer (I)				770000
Less: Unclaimed Depreciation (J) ($1,218,500 * 0.0741)				90290.85
Profit on Sale (K = I-J)				679709.15
Less: Tax @28% (L = K*28%)				190318.562
Profit After sale (M = K-L)				489390.588
Add back Unclaimed Depreciation (N = J)				90290.85
Net Salvage Value (O = M+N)				579681.438
Net Working Capital Recovered (P)				19500
Net Terminal Value (Q = O+P)				599181.438
Total Cash Flows (R = A+H+Q)	-1238000	416115.29	454054.51	952110.196
Present value factor @12% (S) 1/(1+12%)^n n=0,1,2,3	1	0.8928571	0.7971939	0.71178025
Present value of Cash Flows (T = R*S)	-1238000	371531.51	361969.48	677693.231
NPV of the Project	173194.219
NPV of the Project is $173,194.22

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Note:

Required rate of return is not given hence 12% is considered.

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Decision:

NPV is positive at required rate of return 12% and Project is accepted