The Campbell Company is evaluating the proposed acquisition of a new milling mac

Question

The Campbell Company is evaluating the proposed acquisition of a new milling machine. The machine's base price is $95,000, and it would cost another $91,000 to modify it for special use. The machine falls into the MACRS 3-year class, and it would be sold after 3 years for $69,000. 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 $38,000 per year in before-tax operating costs, mainly labor. Campbell's marginal tax rate is 30%.

a) What is the net cost of the machine for capital budgeting purposes? (That is, what is the Year 0 net cash flow?)

b) What are the net operating cash flows in Years 1, 2, and 3? Round your answers to the nearest dollar.

Year 1

Year 2

Year 3

c) What is the additional Year 3 cash flow (that is, the after-tax salvage and the return of working capital)? Round your answer to the nearest dollar.

Explanation / Answer

a)NEt cash flow in year 0 = net cost of machine + working capital

                                     = ( 95,000 +91,000 ) + 5,500

                                    = 186,000 + 5,500

                                    = $ 191,500

b)

7200   (tax saving )

3)Additional year 3 cash flow = 52434.78(after tax salvage) + 5500 (working capital )

                                          =$ 57934.78

**Book value after year 3 = 186000 * 7.41% = $ 13782.60

**sale value = 69000

capital gain = 69000 - 13782.60 = $ 55217.40

capital gain tax= 55217.40 *30% = $ 16565.22

net sale proceeds /after tax salvage value = 69000 - 16565.22 = $ 52434.78

year 1 2 3 saving due to machine 38,000 38,000 38,000 less depreciation [cost =186000 ] (62,000)   [186000*33.33%] (82677)    [186000*44.45%] (27546.60)   [186000*14.81%] net savings - 24000 - 44677 10453.40 less:Tax @ 30%

7200   (tax saving )

13403.1 (tax savings ] (3136.02) Income after tax - 16800 - 31273.90 7317.38 Add:Depreciation (non cash ) 62,000 82,677 27,546 .60 net cash flow 45200 51403.10 34863.98

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