Question

The Campbell Company is considering adding a robotic paint sprayer to its production line. The sprayer’s base price is $1,080,000, and it would cost another $22,500 to install it. The machine falls into the MACRS 3-year class, and it would be sold after 3 years for $605,000. 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 $380,000 per year in before-tax operating costs, mainly labor.

Campbell’s marginal tax rate is 35%.

Answer 1

Part A:

 0 Year Net Cash Flow = -1080000-22500-15500 = -1118000

 Part B: 

	Year1	Year2	Year3
Annual Savings	380000	380000	380000
Less Depreciation	367463	490061	163280
Savings after Depreciation	12537	-110061	216720
Less Taxes	4388	-38521	75852
Savings after Taxes and Depreciation	8149	-71540	140868
Add Depreciation	367463	490061	163280
Operating Cash Flow	375612	418521	304148

 Part C: Additional Cash Flow in Year 3 = 605000 + (605000 - 81695)*(.35) + 15500 = 803657

Part D: 

To calculate IRR, you need to put the value of NPV as 0 and use following equation to derive IRR NPV = 0 = -1118000 + 375612/(1+r)^1 + 418521/(1+r)^2 + (304148 + 803657)/(1+r)^3

  Yes, the machine should be purchased.

  Solving for r, we get IRR as 25.87 or 26%

 

Yes, the machine should be purchased.