Question

The Campbell Company is considering adding a robotic paint sprayer to its production line. The sprayer's base price is $870,000, and it would cost another $25,000 to install it. The machine falls into the MACRS 3-year class, and it would be sold after 3 years for $615,000. 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 $20,000. The sprayer would not change revenues, but it is expected to save the firm $358,000 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.

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 14%, what is the NPV of the project?
$
Should the machine be purchased?
-Select-YesNoItem 7

Answer 1

To calculate the Year-0 net cash flow, we need to sum up all the initial costs and cash flows.

Year-0 net cash flow:
= -Initial cost - Installation cost + Increase in working capital
= -$870,000 - $25,000 + $20,000
= -$875,000

To calculate the net operating cash flows in Years 1, 2, and 3, we need to calculate the depreciation, operating cost savings, and taxes.

Depreciation:
Year 1: $870,000 x 0.3333 = $290,010
Year 2: $870,000 x 0.4445 = $387,065
Year 3: $870,000 x 0.1481 = $128,727

Operating cost savings:
Year 1: $358,000
Year 2: $358,000
Year 3: $358,000

Tax savings (25% of depreciation and operating cost savings):
Year 1: ($290,010 + $358,000) x 0.25 = $162,252.50
Year 2: ($387,065 + $358,000) x 0.25 = $186,766.25
Year 3: ($128,727 + $358,000) x 0.25 = $121,181.25

Net operating cash flows:
Year 1: $358,000 - $162,252.50 = $195,747.50
Year 2: $358,000 - $186,766.25 = $171,233.75
Year 3: $358,000 + $615,000 - $121,181.25 = $851,818.75

To calculate the additional Year-3 cash flow, we need to subtract the tax on the salvage value and add the return of working capital.

Tax on salvage value: (salvage value - book value) x tax rate = ($615,000 - $128,727) x 0.25 = $121,818.25

Additional Year-3 cash flow:
= Salvage value - tax on salvage value + return of working capital
= $615,000 - $121,818.25 + $20,000
= $513,181.75

To calculate the NPV of the project, we need to discount all the cash flows at the project's cost of capital and sum them up.

NPV = -$875,000 + ($195,747.50 / 1.14) + ($171,233.75 / 1.14^2) + ($851,818.75 / 1.14^3) + ($513,181.75 / 1.14^3)
= -$875,000 + $156,868.22 + $129,,356.11 + $502,243.76 + $391,951.41
= $249,419.50

The NPV of the project is $249,419.50, which is positive. Therefore, the machine should be purchased as it is expected to generate a positive return and increase the value of the company.