Question

A Company is considering adding a robotic paint sprayer to its production line. The sprayer’sbase price is $1,080,000, and it would cost another $22,500 to install it. The machine falls into the MACRS 3-year class (33%, 45%, 15% and 7%), and it would be sold after 3 years for $605,000. 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. The company’s marginal tax rate is 35%.

1. a) What is the Year-0 cash flow?

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

3. c) What is the non-operating Year-3 cash flow?

4. d) If the project’s cost of capital is 12%, should the machine be purchased?

Answer 1

a: Year 0 cash flow =

-1118000

b: Net OCF in year 1 =

374338.75

Year 2 OCF =

420643.75

Year 3 OCF =

304881.25

c: Non operating cash flow = Working capital recovery + Salvage after tax

= 15500+ 420261

=435761.25

d: NPV at 12% is

$78,740.35

Since NPV is positive, the machine should be purchased.

WORKINGS

Salvage
Purchase price	1102500
Less: Depreciation	-1025325
Closing book value	77175
Selling price	605000
Gain/(loss)	527825
Tax/ Saving	-184738.75
Net salvage	420261.25

OCF		MACRS 3 year
Year	Cash flows	Depreciation	EBIT	Tax	PAT	OCF
1	380000	-363825	16175	-5661.3	10513.75	374338.75
2	380000	-496125	-116125	40644	-75481.25	420643.75
3	380000	-165375	214625	-75119	139506.25	304881.25

Year	Initial cash flow	OCF	Working capital	Salvage	Net cash flows
0	-1102500		-15500		-1118000
1		$374,338.75			374338.75
2		$420,643.75			420643.75
3		$304,881.25	15500	420261	740642.5