The Campbell Company

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 = $126,000 2. What are the net operating cash flows during Years 1, 2 and 3? Â   | Year | |Â   |0 |1 |2 |3 | |After-Tax Savings |Â   |$28,600 |$28,600 |$28,600 | |Depreciation Tax Savings |Â   |$13,918 |$18,979 |$6,326 | |Net Cash Flow |Â   |$42,518 |$47,579 |$34,926 | . 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 |Cash Flow |PV Factor @ 12% |PV | |0 |($126,000) |1 |($126,000) | |1 |$42,518 |0. 929 |$37,962 | |2 |$47,579 |0. 7972 |$37,929 | |3 |$85,629 |0. 7118 |$60,949 | |NPV |Â   |Â   |$10,840 |