4. The Campbell Company is considering adding a robotic paint sprayer to its pro
ID: 2770138 • Letter: 4
Question
4. The Campbell Company is considering adding a robotic paint sprayer to its production line. The sprayer’s base price is $1,080,000, and it would cost another $22,500 to install it. The machine falls into the MACRS 3-year class, and it would be sold after 3 years for $605,000. 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 $15,500. The sprayer would not change revenues, but it 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 cash flows in Years 1, 2, and 3?
c. What is the additional Year-3 cash flow (i.e., the after-tax salvage and the return of working capital)?
d. If the project’s cost of capital is 12%, should the machine be purchased?
Explanation / Answer
Part A:
0 Year Net Cash Flow = -1080000-22500-15500 = -1118000
Part B:
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
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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