The Campbell Company is considering adding a robotic paint sprayer to its produc
ID: 2702531 • Letter: T
Question
The Campbell Company is considering adding a robotic paint sprayer to its
production line. The sprayer%u2019s 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%u2019s 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%u2019s cost of capital is 12%, should the machine be purchased?
Explanation / Answer
Solution:
Year 0 Net Cash Flow = Base Price + Installation cost + Increase in net working capital
= - $1,080,000 - $22,500 - $$15,500
= - $1,118,000
Note: Minus sign is given because the year is 0.
Particulars
Amount
Amount
Amount
Basic Price + Installation fee
1,102,500
1,102,500
1,102,500
MACRS rate
0.3333
0.4445
0.1481
Particulars
Year 1
Year 2
Year 3
Annual Savings
380,000
380,000
380,000
Depreciation ( Basic Price + Installation Feee) x MACRS rate
367,463
490,061
163,280
Savings after depreciation
12,537
(110,061)
216,720
Tax (35%) calculated on savings after depreciation
4,388
(38,521)
75,852,
Savings after Taxes and depreciation
8,149
(71,540)
140,868
Add: Depreciation
367,463
490,061
163,280
Operating Cash Flow
375,612
418,521
304,148
c. What is the additional Year-3 cash flow (i.e., the after-tax salvage and the return of
working capital)?
Particulars
Amount
Salvage value
605,000
Less: Taxes
184,739
420,261
Add: Net operating working capital
15,500
Terminal year cash flow
435,761
Year
Net cash flows
0
- $1,118,000
1
375,612
2
418,521
3
304,148
IRR
14.43%
Therefore the machine should be purchased because the IRR is 14.43% which is higher than 12% cost of capital.
Particulars
Amount
Amount
Amount
Basic Price + Installation fee
1,102,500
1,102,500
1,102,500
MACRS rate
0.3333
0.4445
0.1481
Particulars
Year 1
Year 2
Year 3
Annual Savings
380,000
380,000
380,000
Depreciation ( Basic Price + Installation Feee) x MACRS rate
367,463
490,061
163,280
Savings after depreciation
12,537
(110,061)
216,720
Tax (35%) calculated on savings after depreciation
4,388
(38,521)
75,852,
Savings after Taxes and depreciation
8,149
(71,540)
140,868
Add: Depreciation
367,463
490,061
163,280
Operating Cash Flow
375,612
418,521
304,148