Question

The Campbell Company is considering adding a robotic paint sprayer to its production line. The sprayer's base price is $1,050,000, and it would cost another $20,500 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 $607,000. 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 $364,000 per year in before-tax operating costs, mainly labor. Campbell's marginal tax rate is 40%.

A) What is the Year 0 net cash flow? $

B) What are the net operating cash flows in Years 1, 2, and 3? Do not round intermediate calculations. Round your answers to the nearest dollar. Year 1 $ Year 2 $ Year 3 $

C) What is the additional Year 3 cash flow (i.e, the after-tax salvage and the return of working capital)? Do not round intermediate calculations. Round your answer to the nearest dollar. $

D) If the project's cost of capital is 10 %, what is the NPV of the project? Do not round intermediate calculations. Round your answer to the nearest dollar. $

Should the machine be purchased?

Answer 1

A) Calculation of Year 0 Net Cash Flow

Particulars	Amount
Cash Outflows :
Sprayer's base price	$1,050,000.00
Add: Installation Expenses	$20,500.00
Add: Increase in net working capital	$19,500.00
Total Cash Flow	$1,090,000.00

B)  Calculation of net operating cash flows in Years 1, 2, and 3

Particulars	1	2	3
Cash Inflows :
Savings in operating costs	$364,000.00	$364,000.00	$364,000.00
Less: Depreciation (note1)	$(356,797.65)	$(475,837.25)	$(158,541.05)
Operating Profits before tax	$7,202.35	$(111,837.25)	$205,458.95
Less: Tax @ 40%	$(2,880.94)	$44,734.90	$(82,183.58)
Operating Profits after tax	$4,321.41	$(17,893.96)	$32,873.43
Add:: Depreciation	$356,797.65	$475,837.25	$158,541.05
Net operating cash flows	$361,119.06	$457,943.29	$191,414.48

Note 1: Calculation of Depreciation

Particulars	Amount	1	2	3	4
Cost of Equipment**	$1,070,500.00	33.33%	44.45%	14.81%	7.41%
Depreciation		$356,797.65	$475,837.25	$158,541.05	$79,324.05

**Cost of Equipment = Sprayer's base price + Installation Expense

C) Calculation of Year 3 Additional Cash Flow:

Particulars	Amount
Additional Cash Inflows:
After tax Salvage Value (Note1)	$395,929.62
Add: Recovery of Working Capital	$19,500.00
Additional Cash Inflows:	$415,429.62

Note 1:

Particulars	Amount
Sale Value ...A	$607,000.00
Cost of Equipment	$1,070,500.00
Less: Accumulated Depreciation	$991,175.95
Book Value at end of Year 3 ...B	$79,324.05
Profit on Sale of Machinery ...(A-B)	$527,675.95
Tax on sale of asset @ 40% ...C	$211,070.38
After tax Salvage Value ...(A-C)	$395,929.62

D) Calculation of  NPV of the project, given cost of capital is 10%

Net Present Value = Present Value of Cash Inflows - Present Valueof Cash Outflows

Particulars	0	1	2	3
Total Cash Outflow	$(1,090,000.00)
Net operating cash inflows		$361,119.06	$457,943.29	$191,414.48
Additional year end Inflows				$415,429.62
Total Cash Flow	$(1,090,000.00)	$361,119.06	$457,943.29	$606,844.10
PVF @ 10%	1	0.909090909	0.826446281	0.751314801
Present value	$(1,090,000.00)	$328,290.05	$378,465.53	$455,930.96

Net Present Value = $(1,090,000.00) + $328,290.05 + $378,465.53 + $455,930.96

Net Present Value = $ 72,686.54

Decision: Since, NPV is positive. It means Present Value of Cash Inflows is greater than Present Value of Cash Outflows
Purchase the machinery.

Note : PVF (r,t) =1/(1+r)^t