Questions from Chapter 11: Cash Flow Estimation

(11-6)

New-Project Analysis

The Campbell Company is considering adding a robotic paint sprayer to its production line.
The sprayer’s base price is RM920,000, and it would cost another RM20,000 to install it. The
machine falls into the MACRS 3-year class, and it would be sold after three years for
RM500,000. The MACRS rates for the first three years are 0.3333, 0.4445 and 0.1481. The
machine would require an increase in net working capital (inventory) of RM15,500. The
sprayer would not change revenues, but it is expected to save the firm RM304,000 per year in
before-tax operating costs, mainly labour. Campbell’s marginal tax rate is 25 percent.
a) What is the Year-0 cash flow?
b) What are the cash flows in Years 1, 2, and 3?
c) What is the additional Year-3 cash flow (i.e., the after-tax salvage and the return of
working capital)?
d) If the project’s cost of capital is 12 percent, what is the NPV?

(11-7)

New-Project Analysis

The president of your company, MorChuck Enterprises, has asked you to evaluate the
proposed acquisition of a new chromatograph for the firm’s R&D department. The
equipment’s basic price is RM70,000 and it would cost another RM15,000 to modify it for
special use by your firm. The chromatograph, which falls into the MACRS 3-year class,
would be sold after three years for RM30,000. The MACRS rates for the first three years are
0.3333, 0.4445 and 0.1481. Use of the equipment would require an increase in net working
capital (spare parts inventory) of RM4,000. The machine would have no effect on revenues,
but it is expected to save the firm RM25,000 per year in before-tax operating costs, mainly
labour. The firm’s marginal federal-plus-state tax rate is 25 percent.
a) What is the Year-0 cash flow?
b) What are the cash flows in Years 1, 2, and 3?
c) What is the additional (nonoperating) cash flow in Year 3?
d) If the project’s cost of capital is 10 percent, should the chromatograph be purchased?