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18 July, 15:42

The Campbell Company is considering adding a robotic paint sprayer to its production line. The sprayer's base price $1,080,000, and it would cost another $22,500 to install it. The machine falls into MACRS 3-year class, and it would be sold after 3 years for $605,000. The MACRS rates for 3 years are 0.333, 0.4445, 0.1481. The machine wold require an increase in the net working capital (inventory) of $15,500. The sprayer would no change revenues, but is expected to save the firm $380,000 per year in before-tax operating costs, mainly labor. Campbell's marginal tax rate is 35%. a. What is the Year 0 net cash flow? b. What are the net operating cash flows in Years 1, 2, 3? c. What is the additional Year 3-cash flow (i. e. after tax salvage and the return of working capital) ?

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

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  1. 18 July, 15:50
    0
    a. What is the Year 0 net cash flow?

    = $1,102,500 + $15,500 = $1,118,000

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

    NCF Year 1 = $375,496.38 NCF Year 2 = $418,521.44 NCF Year 3 = $304,148.09

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

    $355,433.10

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

    NPV = $20,384.22 since it is positive, then the project should be carried out and the machine should be purchased.

    Explanation:

    book value of the robotic sprayer = $1,080,000 + $22,500 = $1,102,500

    useful life 3 years, salvage value $605,000

    MACRS 3-year class:

    0.333 x $1,102,500 = $367,132.50

    0.4445 x $1,102,500 = $490,061.25

    0.1481 x $1,102,500 = $163,280.25

    requires an additional $15,500 investment in inventory

    saves $380,000 per year

    marginal tax rate 35%

    net cash flow year 1 = [net savings x (1 - tax rate) ] + (depreciation expense x tax rate) = ($380,000 x 65%) + ($367,132.50 x 35%) = $247,000 + $128,496.38 = $375,496.38

    net cash flow year 2 = [net savings x (1 - tax rate) ] + (depreciation expense x tax rate) = ($380,000 x 65%) + ($490,061.25 x 35%) = $247,000 + $171,521.44 = $418,521.44

    net cash flow year 3 = [net savings x (1 - tax rate) ] + (depreciation expense x tax rate) = ($380,000 x 65%) + ($163,280.25 x 35%) = $247,000 + $57,148.09 = $304,148.09

    terminal cash flow = [sales price - (purchase cost - accumulated depreciation) ] x (1 - tax rate) + recovered net working capital = [$605,000 - ($1,102,500 - $1,020,474) ] x 0.65 + $15,500 = $355,433.10

    using an excel spreadsheet I calculated the NPV:

    Year 0 - $1,118,000

    Year 1 $375,496.38

    Year 2 $418,521.44

    Year 3 $304,148.09 + $355,433.10 = $659,581.19

    discount rate 12%

    NPV = $20,384.22
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