Question

The Campbell Company is considering adding a robotic paint sprayer to its production line. The sprayer's base price is $1,180,000, and it would cost another $20,500 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 $534,000. 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 $476,000 per year in before-tax operating costs, mainly labor. Campbell's marginal tax rate is 40%.

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

What is the additional Year 3 cash flow (i.e, the after-tax salvage and the return of working capital)?

If the project's cost of capital is 12 %, what is the NPV of the project?

Answer 1

Initial Investment = Base Price + Installation Cost
Initial Investment = $1,180,000 + $20,500
Initial Investment = $1,200,500

Useful Life = 3 years

Depreciation Year 1 = 33.33% * $1,200,500
Depreciation Year 1 = $400,126.65

Depreciation Year 2 = 44.45% * $1,200,500
Depreciation Year 2 = $533,622.25

Depreciation Year 3 = 14.81% * $1,200,500
Depreciation Year 3 = $177,794.05

Book Value at the end of Year 3 = $1,200,500 - $400,126.65 - $533,622.25 - $177,794.05
Book Value at the end of Year 3 = $88,957.05

After-tax Salvage Value = Salvage Value - (Salvage Value - Book Value) * tax rate
After-tax Salvage Value = $534,000 - ($534,000 - $88,957.05) * 0.40
After-tax Salvage Value = $355,982.82

Initial Investment in NWC = $17,000

Year 0:

Net Cash Flows = Initial Investment + Initial Investment in NWC
Net Cash Flows = -$1,200,500 - $17,000
Net Cash Flows = -$1,217,500

Year 1:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $476,000 * (1 - 0.40) + 0.40 * $400,126.65
Operating Cash Flow = $445,650.66

Year 2:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $476,000 * (1 - 0.40) + 0.40 * $533,622.25
Operating Cash Flow = $499,048.90

Year 3:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $476,000 * (1 - 0.40) + 0.40 * $177,794.05
Operating Cash Flow = $356,717.62

Additional Cash Flows = NWC recovered + After-tax Salvage Value
Additional Cash Flows = $17,000 + $355,982.82
Additional Cash Flows = $372,982.82

Cost of Capital = 12%

NPV = -$1,217,500 + $445,650.66/1.12 + $499,048.90/1.12^2 + $356,717.62/1.12^3 + $372,982.82/1.12^3
NPV = $97,627.46