Question

New-Project Analysis

The Campbell Company is considering adding a robotic paint sprayer to its production line. The sprayer's base price is $900,000, and it would cost another $25,000 to install it. The machine falls into the MACRS 3-year class, and it would be sold after 3 years for $547,000. 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 $17,000. The sprayer would not change revenues, but it is expected to save the firm $386,000 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 15%, what is the NPV of the project?

   $  

   Should the machine be purchased?

Answer 1

Initial Investment = Base Price + Installation Cost
Initial Investment = $900,000 + $25,000
Initial Investment = $925,000

Useful Life = 3 years

Depreciation Year 1 = 0.3333 * $925,000
Depreciation Year 1 = $308,302.50

Depreciation Year 2 = 0.4445 * $925,000
Depreciation Year 2 = $411,162.50

Depreciation Year 3 = 0.1481 * $925,000
Depreciation Year 3 = $136,992.50

Book Value at the end of Year 3 = $925,000 - $308,302.50 - $411,162.50 - $136,992.50
Book Value at the end of Year 3 = $68,542.50

After-tax Salvage Value = Salvage Value - (Salvage Value - Book Value) * tax rate
After-tax Salvage Value = $547,000 - ($547,000 - $68,542.50) * 0.25
After-tax Salvage Value = $427,386

Initial Investment in NWC = $17,000

Answer a.

Year 0:

Net Cash Flows = Initial Investment + Initial Investment in NWC
Net Cash Flows = -$925,000 - $17,000
Net Cash Flows = -$942,000

Answer b.

Year 1:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $386,000 * (1 - 0.25) + 0.25 * $308,302.50
Operating Cash Flow = $366,576

Year 2:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $386,000 * (1 - 0.25) + 0.25 * $411,162.50
Operating Cash Flow = $392,291

Year 3:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $386,000 * (1 - 0.25) + 0.25 * $136,992.50
Operating Cash Flow = $323,748

Answer c.

Additional Cash Flows = NWC recovered + After-tax Salvage Value
Additional Cash Flows = $17,000 + $427,386
Additional Cash Flows = $444,386

Answer d.

Required Return = 15%

NPV = -$942,000 + $366,576/1.15 + $392,291/1.15^2 + $323,748/1.15^3 + $444,386/1.15^3
NPV = $178,451

NPV of the machine is positive. So, you should purchase the machine.