The Campbell Company is considering adding a robotic paint sprayer to its produc
ID: 2655026 • Letter: T
Question
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 operating 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. Based on your IRR analysis, if the project’s cost of capital is 12%, should the machine be purchased?
Please answer question d. The correct answer is $78,790. Please show work.
Explanation / Answer
a. What is the Year 0 net cash flow?
Year 0 net cash flow = -1080000 - 22500 -15500
Year 0 net cash flow = - 1,118,000
b. What are the net operating cash flows in Years 1, 2, and 3?
Net operating cash flows in Years 1 = before-tax operating costs*(1-tax rate) + Depreciation*tax rate
Net operating cash flows in Years 1 = 380000*(1-35%) + (1080000+22500)*0.3333*35%
Net operating cash flows in Years 1 = 375,612.14
Net operating cash flows in Years 2 = before-tax operating costs*(1-tax rate) + Depreciation*tax rate
Net operating cash flows in Years 2 = 380000*(1-35%) + (1080000+22500)*0.4445*35%
Net operating cash flows in Years 2 = 418,521.44
Net operating cash flows in Years 3 = before-tax operating costs*(1-tax rate) + Depreciation*tax rate
Net operating cash flows in Years 3 = 380000*(1-35%) + (1080000+22500)*0.1481*35%
Net operating cash flows in Years 3 = 304,148.09
c. What is the additional Year-3 cash flow (i.e., the after-tax salvage and the return of
working capital)?
Additional Year-3 cash flow = 605000 - (605000 - (1080000+22500)*(1-0.3333-0.4445-0.1481))*35% + 15500
Additional Year-3 cash flow = $ 437,343.34
d. Based on your IRR analysis, if the project’s cost of capital is 12%, should the machine be purchased?
NPV = Year 0 net cash flow + Net operating cash flows in Years 1 /1.12 + Net operating cash flows in Years 2/1.12^2 + Net operating cash flows in Years 3/1.12^3 + Additional Year-3 cash flow/1.12^3
NPV = - 1118000 + 375,612.14/1.12 + 418,521.44/1.12^2 + 304,148.09/1.12^3 + 437,343.34/1.12^3
NPV = 78,789.67
NPV = 78,790
Since NPV is positive IRR is greater than the Cost of capital therefore the machine should be purchased,