The Campbell Company is evaluating a proposal to buy a new milling machine. The base price is $108,000, and shipping and installation costs would add another $12,500. The machine falls into the MACRS 3-year class, and it would be sold after 3 years for $65,000. The machine would require a $5,500 increase in working capital (increased inventory less increased accounts payable). There would be no effect on revenues, but pre-tax labor costs would decline by $44,000 per year. The marginal tax rate is 35 percent.
1. What is the net cost of the machine for capital budgeting purposes, that is, the Year 0 project cash flow?
Net Cost of the machine
= $108,000 + $12,500 + $5,500
2. What are the net operating cash flows during Years 1, 2 and 3?
| | Year | | |0 |1 |2 |3 | |After-Tax Savings | |$28,600 |$28,600 |$28,600 | |Depreciation Tax Savings | |$13,918 |$18,979 |$6,326 | |Net Cash Flow | |$42,518 |$47,579 |$34,926 |
3. What is the terminal year cash flow?
|Salvage Value |$65,000 |
|Tax on Salvage Value |$19,798 |
|NWC Recovery |$5,500 |
|Terminal Cash Flow |$50,702 |
4. If the project’s cost of capital (WACC) is 12 percent, should the machine be purchased?
Yes, the machine should be purchased as the investment has a positive NPV of $10,840 as per the following table.
|NPV Analysis | |Year...
Please join StudyMode to read the full document