Question

The Campbell Company is considering adding a robotic paint sprayer to its production line. The sprayer's base price is $1,150,000, and it would cost another $20,000 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 $580,000. 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 $462,000 per year in before-tax operating costs, mainly labor. Campbell's marginal tax rate is 30%. Cash outflows, if any, should be indicated by a minus sign. Do not round intermediate calculations. Round your answers to the nearest dollar.

What is the Year-0 net cash flow?

$

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

Year 1:   $
Year 2:   $
Year 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 15 %, what is the NPV of the project?

$

Should the machine be purchased?

Answer 1

Initial Investment = Base Price + Installation Cost
Initial Investment = $1,150,000 + $20,000
Initial Investment = $1,170,000

Useful Life = 3 years

Depreciation Year 1 = 33.33% * $1,170,000
Depreciation Year 1 = $389,961

Depreciation Year 2 = 44.45% * $1,170,000
Depreciation Year 2 = $520,065

Depreciation Year 3 = 14.81% * $1,170,000
Depreciation Year 3 = $173,277

Book Value at the end of Year 3 = $1,170,000 - $389,961 - $520,065 - $173,277
Book Value at the end of Year 3 = $86,697

After-tax Salvage Value = Salvage Value - (Salvage Value - Book Value) * tax rate
After-tax Salvage Value = $580,000 - ($580,000 - $86,697) * 0.30
After-tax Salvage Value = $432,009

Initial Investment in NWC = $13,000

Answer a.

Year 0:

Net Cash Flows = Initial Investment + Initial Investment in NWC
Net Cash Flows = -$1,170,000 - $13,000
Net Cash Flows = -$1,183,000

Answer b.

Year 1:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $462,000 * (1 - 0.30) + 0.30 * $389,961
Operating Cash Flow = $440,388

Year 2:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $462,000 * (1 - 0.30) + 0.30 * $520,065
Operating Cash Flow = $479,420

Year 3:

Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Operating Cash Flow = $462,000 * (1 - 0.30) + 0.30 * $173,277
Operating Cash Flow = $375,383

Answer c.

Additional Cash Flows = NWC recovered + After-tax Salvage Value
Additional Cash Flows = $13,000 + $432,009
Additional Cash Flows = $445,009

Answer d.

Cost of Capital = 15%

NPV = -$1,183,000 + $440,388/1.15 + $479,420/1.15^2 + $375,383/1.15^3 + $445,009/1.15^3
NPV = $101,878

Yes, the machine should be purchased as NPV is positive.