The Campbell Company is evaluating the proposed acquisition of a new milling machine. The machine's base price is $108,000, and it would cost another $12,500 to modify it for special use. The maintenance cost of the machine is RM30,000 per annum.

A. What is the net cost of the machine for capital budgeting purposes?

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

C. What is the terminal year cash flow?

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

Missing information:

The machine falls into the MACRS 3-year class, and it would be sold after 3 years for $65,000. The machine would require an increase in net working capital (inventory) of $5,500. The milling machine would have no effect on revenues, but it is expected to save the firm $44,000 per year in before-tax operating costs, mainly labor. Campbell's marginal tax rate is 35%

Answer:

A. What is the net cost of the machine for capital budgeting purposes?

machine's base price + cost of modifications + increase in inventory = $108,000 + $12,500 + $5,500 = $126,000

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

NCF year 1 = $42,517.75 NCF year 2 = $47,578.75 NCF year 3 = $34,926.25

C. What is the terminal year cash flow?

$50,702.25 + $34,926.25 = $85,628.50

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

NPV = $10,840.44, since it is positive, then the project should be carried out and the machine should be purchased.

Explanation:

net cash flow year 1 = [net savings x (1 - tax rate) ] + (depreciation expense x tax rate) = ($44,000 x 65%) + ($39,765 x 35%) = $28,600 + $13,917.75 = $42,517.75

net cash flow year 2 = [net savings x (1 - tax rate) ] + (depreciation expense x tax rate) = ($44,000 x 65%) + ($54,225 x 35%) = $28,600 + $18,978.75 = $47,578.75

net cash flow year 3 = [net savings x (1 - tax rate) ] + (depreciation expense x tax rate) = ($44,000 x 65%) + ($18,075 x 35%) = $28,600 + $6,326.25 = $34,926.25

terminal cash flow = [sales price - (purchase cost - accumulated depreciation) ] x (1 - tax rate) = [$65,000 - ($120,500 - $112,065) ] x 0.65 = $50,702.25

Year cash flow

0 - $126,000

1 $42,517.75

2 $47,578.75

3 $85,628.50

discount rate 12%

using an excel spreadsheet, NPV = $10,840.44