Question

New-Project Analysis

The Campbell Company is considering adding a robotic paint sprayer to its production line. The sprayer's base price is $1,130,000, and it would cost another $16,000 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 $589,000. The machine would require an increase in net working capital (inventory) of $14,500. The sprayer would not change revenues, but it is expected to save the firm $423,000 per year in before-tax operating costs, mainly labor. Campbell's marginal tax rate is 35%. Cash outflows, if any, should be indicated by a minus sign. Do not round intermediate calculations. Round your answers to the nearest dollar.

a) What is the Year-0 net cash flow?

$  

b) What are the net operating cash flows in Years 1, 2, and 3?

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)?

$  

d) If the project's cost of capital is 14 %, what is the NPV of the project?

$  

Should the machine be purchased?

-Select-Yes OR No

Answer 1

Initial Investment = Base Price + Installation Cost
Initial Investment = $1,130,000 + $16,000
Initial Investment = $1,146,000

Useful Life = 3 years

Depreciation Year 1 = 33.33% * $1,146,000
Depreciation Year 1 = $381,961.80

Depreciation Year 2 = 44.45% * $1,146,000
Depreciation Year 2 = $509,397.00

Depreciation Year 3 = 14.81% * $1,146,000
Depreciation Year 3 = $169,722.60

Book Value at the end of Year 3 = $1,146,000 - $381,961.80 - $509,397 - $169,722.60
Book Value at the end of Year 3 = $84,918.60

After-tax Salvage Value = Salvage Value - (Salvage Value - Book Value) * tax rate
After-tax Salvage Value = $589,000 - ($589,000 - $84,918.60) * 0.35
After-tax Salvage Value = $412,571.51

Initial Investment in NWC = $14,500

Answer a.

Year 0:

Net Cash Flows = Initial Investment + Initial Investment in NWC
Net Cash Flows = -$1,146,000 - $14,500
Net Cash Flows = -$1,160,500

Answer b.

Year 1:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $423,000 * (1 - 0.35) + 0.35 * $381,961.80
Operating Cash Flow = $408,636.63

Year 2:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $423,000 * (1 - 0.35) + 0.35 * $509,397
Operating Cash Flow = $453,238.95

Year 3:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $423,000 * (1 - 0.35) + 0.35 * $169,722.60
Operating Cash Flow = $334,352.91

Answer c.

Year 3:

Additional Cash Flow = NWC recovered + After-tax Salvage Value
Additional Cash Flow = $14,500 + $412,571.51
Additional Cash Flow = $427,071.51

Answer d.

Cost of Capital = 14%

NPV = -$1,160,500 + $408,636.63/1.14 + $453,238.95/1.14^2 + $334,352.91/1.14^3 + $427,071.51/1.14^3
NPV = $60,645.63

NPV of the project is $60,645.63

Yes, you should purchase this machine as NPV of the project is positive.