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The Campbell Company

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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?

| | 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
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