Question

New-Project Analysis

The Campbell Company is considering adding a robotic paint sprayer to its production line. The sprayer's base price is $840,000, and it would cost another $18,500 to install it. The machine falls into the MACRS 3-year class, and it would be sold after 3 years for $617,000. 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 $13,000. The sprayer would not change revenues, but it is expected to save the firm $315,000 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 14%, what is the NPV of the project?

   $  

   Should the machine be purchased?

   -Select-YesNo

Answer 1

Initial Investment = Base Price + Installation Cost
Initial Investment = $840,000 + $18,500
Initial Investment = $858,500

Useful Life = 3 years

Depreciation Year 1 = 0.3333 * $858,500
Depreciation Year 1 = $286,138.05

Depreciation Year 2 = 0.4445 * $858,500
Depreciation Year 2 = $381,603.25

Depreciation Year 3 = 0.1481 * $858,500
Depreciation Year 3 = $127,143.85

Book Value at the end of Year 3 = $858,500 - $286,138.05 - $381,603.25 - $127,143.85
Book Value at the end of Year 3 = $63,614.85

After-tax Salvage Value = Salvage Value - (Salvage Value - Book Value) * tax rate
After-tax Salvage Value = $617,000 - ($617,000 - $63,614.85) * 0.25
After-tax Salvage Value = $478,654

Initial Investment in NWC = $13,000

Answer a.

Year 0:

Net Cash Flows = Initial Investment + Initial Investment in NWC
Net Cash Flows = -$858,500 - $13,000
Net Cash Flows = -$871,500

Answer b.

Year 1:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $315,000 * (1 - 0.25) + 0.25 * $286,138.05
Operating Cash Flow = $307,785

Year 2:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $315,000 * (1 - 0.25) + 0.25 * $381,603.25
Operating Cash Flow = $331,651

Year 3:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $315,000 * (1 - 0.25) + 0.25 * $127,143.85
Operating Cash Flow = $268,036

Answer c.

Additional Cash Flows = NWC recovered + After-tax Salvage Value
Additional Cash Flows = $13,000 + $478,654
Additional Cash Flows = $491,654

Answer d.

Cost of Capital = 14%

NPV = -$871,500 + $307,785/1.14 + $331,651/1.14^2 + $268,036/1.14^3 + $491,654/1.14^3
NPV = $166,451

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