New Project Analysis

The Campbell Company is evaluating the proposed acquisition of a new milling machine. The machine’s base price is $108,000, and it would cost another $12,500 to modify it for special use. 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%.

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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?

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

d. If the project’s cost of capital is 12%, should the machine be purchased?

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