Missing information:
The machine falls into the MACRS 3-year class, and it would be sold after 3 years for $65,000. The machine would require an increase in net working capital (inventory) of $5,500. The milling machine would have no effect on revenues, but it is expected to save the firm $44,000 per year in before-tax operating costs, mainly labor. Campbell’s marginal tax rate is 35%
Answer:
A. What is the net cost of the machine for capital budgeting purposes?
- machine's base price + cost of modifications + increase in inventory = $108,000 + $12,500 + $5,500 = $126,000
B. What are the net operating cash flows in Years 1, 2, and 3?
- NCF year 1 = $42,517.75
- NCF year 2 = $47,578.75
- NCF year 3 = $34,926.25
C. What is the terminal year cash flow?
- $50,702.25 + $34,926.25 = $85,628.50
D. If the project's cost of capital is 12 percent, should the machine be purchased?
- NPV = $10,840.44, since it is positive, then the project should be carried out and the machine should be purchased.
Step-by-step explanation:
net cash flow year 1 = [net savings x (1 - tax rate)] + (depreciation expense x tax rate) = ($44,000 x 65%) + ($39,765 x 35%) = $28,600 + $13,917.75 = $42,517.75
net cash flow year 2 = [net savings x (1 - tax rate)] + (depreciation expense x tax rate) = ($44,000 x 65%) + ($54,225 x 35%) = $28,600 + $18,978.75 = $47,578.75
net cash flow year 3 = [net savings x (1 - tax rate)] + (depreciation expense x tax rate) = ($44,000 x 65%) + ($18,075 x 35%) = $28,600 + $6,326.25 = $34,926.25
terminal cash flow = [sales price - (purchase cost - accumulated depreciation)] x (1 - tax rate) = [$65,000 - ($120,500 - $112,065)] x 0.65 = $50,702.25
Year cash flow
0 -$126,000
1 $42,517.75
2 $47,578.75
3 $85,628.50
discount rate 12%
using an excel spreadsheet, NPV = $10,840.44