Question

The Campbell Company is considering adding a robotic paint sprayer to its production line. The sprayer's base price is $960,000, and it would cost another $17,000 to install it. The machine falls into the MACRS 3-year class, and it would be sold after 3 years for $461,000. The MACRS rates for the first three years are 0.3333, 0.4445, and 0.1481. The machine would require an increase in net working capital (inventory) of $16,000. The sprayer would not change revenues, but it is expected to save the firm $344,000 per year in before-tax operating costs, mainly labor. Campbell's marginal tax rate is 25%. (Ignore the half-year convention for the straight-line method.) 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 12%, what is the NPV of the project?

Answer 1

a. Year 0 net cash flow : - $ 993,000

Installed cost of asset = $ 960,000 + $ 17,000 = $ 977,000.

Year 0 net cash flow = - $ 977,000 - $ 16,000 = - $ 993,000

b. Net Operating Cash Flows:

Net operating cash flows after taxes = Annual Savings x ( 1 - t ) + Annual Depreciation x t

Year 1: 344,000 x 0.75 + 977,000 x 0.3333 x 0.25 = 339,409

Year 2: 344,000 x 0.75 + 977,000 x 0.4445 x 0.25 = 366,569

Year 3: 344,000 x 0.75 + 977,000 x 0.1481 x 0.25 = 294,173

c. Additional Year 3 cash flow: $ 379,849

Book value of asset at the end of Year 3 = 977,000 x 0.0741 = 72,395.70

Gain on salvage = 461,000 - 72,395.70 = 388,604.30

Tax on gain = 388,604.30 x 25 % = 97,151

After tax salvage proceeds = $ 461,000 - $ 97,151 = $ 363,849

Additional cash flow in Year 3 = $ 363,849 + $ 16,000 = $ 379,849

d. NPV : $ 82,056

Year	0	1	2	3
Initial Investment	(993,000)
Operating Cash Flows		339,409	366,569	294,173
Additional Cash Flows				379,849
Total Cash Flows	(993,000)	339,409	366,569	674,022
PV factor at 12 %	1.0000	0.8929	0.7972	0.7118
Present Values	(993,000)	303,058.30	292,228.81	479,768.86
NPV	82,055.97