Question

The Campbell Company is considering adding a robotic paint sprayer to its production line. The sprayer's base price is $820,000, and it would cost another $17,500 to install it. The machine falls into the MACRS 3-year class, and it would be sold after 3 years for $549,000. 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 $15,500. The sprayer would not change revenues, but it is expected to save the firm $381,000 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 13%, what is the NPV of the project?

   $   

   Should the machine be purchased?

   -Select-YesNoItem 7

Answer 1

a. year 0 net cash flow = -(cost of sprayer + installation cost + increase in net working capital) = -($820,000 + $17,500 + $15,500) = -$853,000‬

b. net operating cash flows in Years 1, 2, and 3 are as below:

Year 1:	$355,535
Year 2:	$378,817
Year 3:	$759,523

c.  the additional Year-3 cash flow = after-tax salvage value + return of working capital

after-tax salvage value = salvage value - tax on salvage value

Tax on salvage value = (salvage value - book value)*tax rate

book value = total cost of sprayer - accumulated depreciation for 3 years = $837,500 - ($837,500*0.9259‬) = $837,500 - $775,441.25 = $62,058.75

0.9259 is total of depreciation rates for 3 years.

tax on salvage value = ($549,000 - $62,058.75)*25% = $486,941.25*25% = $121,735.3125‬

after-tax salvage value = $549,000 - $121,735.3125 = $427,264.6875‬

the additional Year-3 cash flow = $427,264.6875‬‬ + $15,500 = $442,765

d. NPV of the project is $284,690. Yes, the machine should be purchased because NPV is positive.

NPV = present value of cash flows - initial investment - increase in net working capital

	Years	0	1	2	3	Total
	Initial investment	-$837,500.00	$0.00	$0.00	$0.00	-$837,500.00
	Increase in net working capital	-$15,500.00	$0.00	$0.00	$0.00	-$15,500.00
	Savings in operating costs	$0.00	$381,000.00	$381,000.00	$381,000.00	$1,143,000.00
Less:	Depreciation	$0.00	$279,138.75	$372,268.75	$124,033.75	$775,441.25
	before-tax cash flows	$0.00	$101,861.25	$8,731.25	$256,966.25	$367,558.75
Less:	Taxes @ 25%	$0.00	$25,465.31	$2,182.81	$64,241.56	$91,889.69
	after-tax cash flows	$0.00	$76,395.94	$6,548.44	$192,724.69	$275,669.06
Add back:	Depreciation	$0.00	$279,138.75	$372,268.75	$124,033.75	$775,441.25
Add back:	working capital recovery	$0.00	$0.00	$0.00	$15,500.00	$15,500.00
Add:	salvage value	$0.00	$0.00	$0.00	$549,000.00	$549,000.00
Less:	Tax on salvage value	$0.00	$0.00	$0.00	$121,735.31	$121,735.31
	net operating cash flows	-$853,000.00	$355,534.69	$378,817.19	$759,523.13	$640,875.00
	NPV of the project	$284,690