The Campbell Company is considering adding a robotic paint sprayer to its produc

Question

The Campbell Company is considering adding a robotic paint sprayer to its production line. The sprayer's base price is $880,000, and it would cost another $21,000 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 $675,000. The machine would require an increase in net working capital (inventory) of $17,000. The sprayer would not change revenues, but it is expected to save the firm $479,000 per year in before-tax operating costs, mainly labor. Campbell's marginal tax rate is 35%.

Year 1 $    Year 2 $    Year 3 $   

Explanation / Answer

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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

Answer

Part A:

0 Year Net Cash Flow = -1080000-22500-15500 = -1118000

Part B:

Part C:

Additional Cash Flow in Year 3 = 605000 + (605000 - 81695)*(.35) + 15500 = 803657

Part D:

To calculate IRR, you need to put the value of NPV as 0 and use following equation to derive IRR

NPV = 0 = -1118000 + 375612/(1+r)^1 + 418521/(1+r)^2 + (304148 + 803657)/(1+r)^3

Solving for r, we get IRR as 25.87 or 26%

Yes, the machine should be purchased.

Year1 Year2 Year3 Annual Savings 380000 380000 380000 Less Depreciation 367463 490061 163280 Savings after Depreciation 12537 -110061 216720 Less Taxes 4388 -38521 75852 Savings after Taxes and Depreciation 8149 -71540 140868 Add Depreciation 367463 490061 163280 Operating Cash Flow 375612 418521 304148

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