Capital budgetingCost of equipment $200,000Shipping $10,000Installation $30,000Economic life 4 yearsSalvage value $25,000Inflation rate 3% per yearMACRS 3-year class

MACRS 3-year scheduleYear Percent Initial basis Depr. Cost

1 33.33% $240,000 $79,992 2 44.45% $106,680 3 14.81% $35,544 4 7.41% $17,784

Annual unit sales 1250Unit sales price 200Unit costs 100Net working capital 12% of sales next periodTax rate 40%Project cost of capital 10% WACC

Year0 1 2 3

Unit sales 1,250 1,250 1,250Sales price $200.0 $206.0Sales value $250,000.0Unit costs $100.0Product costs $125,000Gross profits $125,000Depreciation costs $79,992 EBIT $45,008 Tax $18,003 NOPAT $27,005 Net Operating Cash Flows $106,997

Investment cash flows:Initial cost (equip, shipping & install.)NWCInvestment in NWCRecovery of NWC

Salvage valueRemaining book valueGain or lossIncome taxAfter-tax salvage value

Net Cash FlowsCumulative Net Cash Flows

PV of Net CFsCumulative PV of Net CFs

NPVIRRMIRRPayback yearsDiscounted payback years

Sensitivity AnalysisChange in unit sales NPV IRR-30%-20%-10%0%10%20%30%

* Can perform sensitivity analysis with change in WACC, salvage value, etc.

Scenario Analysis:Probability Unit Sales Unit price NPV

Best scenario 0.25 1600 $240 Base scenario 0.50 1250 $200 Worst scenario 0.25 900 $160

Year4

1,250

= NOPAT + Depreciation

$25,000

IRR P*NPVi

E(NPV)=Variance(NPV)=Stdev(NPV)=CV(NPV)=

P[NPVi - E(NPV)] 2

Replacement Analysis

Applies to:

Part I. Inputs:

Cost of new machine

After-tax salvage value old machine $400

Sales revenues (fixed) $2,500

Annual operating costs except depreciation $1,200

Tax rate 40%

WACC 10%

Depreciation 1 2 3

Depr. rates (new machine) 33.33% 44.45% 14.81%

Depreciation on new machine $667 $889 $296

Depreciation on old machine $400 $400 $400

$267 $489 -$104

Part II. Net Cash Flows before Replacement: Old Machine0 1

Sales revenues $2,500

Operating costs except depreciation 1,200

Depreciation 400

Total operating costs $1,600

Operating income $900

Taxes 40% 360

After-tax operating income $540

Add back depreciation 400

$0 $940

Part III. Net Cash Flows after Replacement: New Machine0 1

New machine cost: -$2,000

After-tax salvage value, old machine $400

Sales revenues $2,500

Operating costs except depreciation 280

Depreciation 667

Total operating costs $947

Operating income $1,553

Taxes 40% 621

After-tax operating income $932

Add back depreciation 667

-$1,600 $1,599

Part IV. Incremental CF: Row 47 - Row 34 -$1,600 $659

Part V. Evaluation NPV = IRR =

As this model is set up, the cost of the new machine, the salvage value of the old machine, the tax rate, the WACC, and the operating costs before depreciation for the new machine can be varied and the output will automatically recalculate. Only these input variables, in BLUE TYPE, should be changed unless you want to modify the model, which could be a fairly big job.

Both Machines

Old Machine

∆: Change in depreciation

Net cash flows before replacement

Net cash flows after replacement

Replacement Analysis

$2,000

$280

4 Totals:

7.41% 100%

$148 $2,000 MACRS

$400 $1,600 straightline depreciation

-$252 $400

Part II. Net Cash Flows before Replacement: Old Machine2 3 4

$2,500 $2,500 $2,500

Part III. Net Cash Flows after Replacement: New Machine2 3 4

MIRR =

As this model is set up, the cost of the new machine, the salvage value of the old machine, the tax rate, the WACC, and the operating costs before depreciation for the new machine can be varied and the output will automatically recalculate. Only these input variables, in BLUE

, should be changed unless you want to modify the model, which could be a fairly big job.

New Machine

Problem 6: The Campbell Company is considering adding a robotic paint sprayer to its production line. The sprayer’s base price is $1,080,000, and it would cost another $22,500 to install it. The machine falls into the MACRS 3-year class, and it would be sold after 3 years for $605,000. The machine would require an increase in net working capital (inventory) of $15,500. The sprayer would not change revenues, but it is expected to save the firm $380,000 per year in before-tax operating costs, mainly labor. Campbell’s marginal tax rate is 35%.a. What is the Year-0 net cash fow?b. What are the net operating cash fows in Years 1 , 2, and 3?c. What is the additional Year-3 cash fow (i.e., 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?

Problem 10: St. Johns River Shipyards’s welding machine is 15 years old, fully depreciated, obsolete, and has no salvage value. However, even though it is obsolete, it is perfectly functional as originally designed and can be used for quite a while longer. A new welder will cost $182,500 and have an estimated life of 8 years with no salvage value. The new welder will be much more effcient, however, and this enhanced effciency will increase earnings before depreciation from $27,000 to $74,000 per year. The new machine will be depreciated over its 5-year MACRS recovery period, so the applicable depreciation rates are 20.00%, 32.00%, 19.20%, 11.52%, 11.52%, and 5.76%. The applicable corporate tax rate is 40%, and the frm’s WACC is 12%. Should the old welder be replaced by the new one?

Initial outlay 1,080,000Year Percent Initial basis

Installation 22,500 1 33.33% $1,080,000 NWC 15,500 2 44.45%Total cash outlay 1,118,000 3 14.81%

4 7.41%

After-tax savings $247,000

Depreciation tax savings 125,987Net cash flow $375,612

Salvage value 605000Remaining book value $80,028 Gain/lossTax amountAfter-tax salvage value

NWC recovery

NPVIRRMIRR

Year 1 Year 2 Year 3

Cost of new machine $182,500

$182,500

After-taxYear Earnings1 $28,200 $14,600 $42,800 2345678

NPVIRRMIRR

Net investment outlay (CF0)

T(DDep) Annual CF t

Depr. Cost

$359,964 $125,987 $480,060 $168,021 $159,948 $55,982 $80,028 $28,010

Derepciation tax savings