Capital budgeting

Cost of equipment
Shipping
Installation
Economic life
Salvage value
Inflation rate
MACRS 3-year class

$200,000
$10,000
$30,000
4 years
$25,000
3% per year
MACRS 3-year schedule
Year
1
2
3
4

Annual unit sales

Unit sales price
Unit costs
Net working capital
Tax rate
Project cost of capital

Percent
33.33%
44.45%
14.81%
7.41%

Initial basis
$240,000

1250
200
100
12% of sales next period
40%
10% WACC
Year
0

Unit sales
Sales price
Sales value
Unit costs
Product costs
Gross profits
Depreciation costs
EBIT
Tax
NOPAT
Net Operating Cash Flows
Investment cash flows:
Initial cost (equip, shipping & install.)
NWC
Investment in NWC
Recovery of NWC
Salvage value

1
1,250
$200.0
$250,000.0
$100.0
$125,000
$125,000
$79,992
$45,008
$18,003
$27,005
$106,997

2
1,250
$206.0

Remaining book value

Gain or loss
Income tax
After-tax salvage value
Net Cash Flows
Cumulative Net Cash Flows
PV of Net CFs
Cumulative PV of Net CFs

NPV
IRR
MIRR
Payback
Discounted payback

years
years

Sensitivity Analysis
Change in unit sales
-30%
-20%
-10%
0%
10%
20%
30%

NPV

IRR

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

Scenario Analysis:
Best scenario
Base scenario
Worst scenario

Probability
0.25
0.50
0.25

Unit Sales
1600
1250
900

Unit price
$240
$200
$160

Depr. Cost
$79,992
$106,680
$35,544
$17,784

Year
3
1,250

4
1,250

= NOPAT + Depreciation

$25,000

NPV

IRR

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

P*NPVi

P[NPVi - E(NPV)]2

Replacement Analysis

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
machine can be varied and the output will automatically recalculate. Only these input variables, in BLUE TYPE, should
could be a fairly big job.

Part I. Inputs:
Cost of new machine
After-tax salvage value old machine
Sales revenues (fixed)
Annual operating costs except depreciation
Tax rate
WACC
Depreciation

1
Depr. rates (new machine)
33.33%
Depreciation on new machine $667
Depreciation on old machine
$400

: Change in depreciation $267

Part II. Net Cash Flows before Replacement: Old Machine
Sales revenues
Operating costs except depreciation
Depreciation
Total operating costs
Operating income
Taxes
After-tax operating income
Add back depreciation
Net cash flows before replacement

40%

Part III. Net Cash Flows after Replacement: New Machine

New machine cost:
After-tax salvage value, old machine
Sales revenues
Operating costs except depreciation
Depreciation
Total operating costs
Operating income
Taxes
40%
After-tax operating income

Add back depreciation

Net cash flows after replacement

Part IV. Incremental CF: Row 47 - Row 34

Part V. Evaluation

NPV =

acement Analysis

machine, the tax rate, the WACC, and the operating costs before depreciation for the new
nput variables, in BLUE TYPE, should be changed unless you want to modify the model, which

Applies to:
Both Machines Old Machine

New Machine
$2,000

$400
$2,500
$1,200

$280

40%
10%
2
44.45%
$889
$400

3
14.81%
$296
$400

$489

4
7.41%
$148
$400

-$104
0

$0
0
-$2,000
$400

-$252

Totals:
100%
$2,000 MACRS
$1,600 straightline depreciation
$400

1
$2,500
1,200
400
$1,600
$900
360
$540
400
$940

2
$2,500

3
$2,500

4
$2,500

$2,500
280
667
$947
$1,553
621
$932

-$1,600

667
$1,599

-$1,600

$659
IRR =

MIRR =

Problem 6: The Campbell Company is considering adding a robotic paint sprayer to its
production line. The sprayers 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. Campbells
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 projects cost of capital is 12%, should the machine be purchased?

Problem 10: St. Johns River Shipyardss 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 frms WACC is 12%. Should the old welder be replaced by the new one?

Initial outlay
Installation
NWC
Total cash outlay

1,080,000
22,500
15,500
1,118,000

Year 1
After-tax savings

$247,000

Depreciation tax savings

Net cash flow

125,987
$375,612

Salvage value
Remaining book value
Gain/loss
Tax amount
After-tax salvage value
NWC recovery
NPV
IRR
MIRR

605000
$80,028

Year 2

Year

Percent

1
2
3
4

33.33%
44.45%
14.81%
7.41%

Year 3

Cost of new machine

$182,500

Net investment outlay (CF0)

$182,500

Year
1
2
3
4
5
6
7
8
NPV
IRR
MIRR

After-tax
Earnings
$28,200

T(Dep)
$14,600

Annual CFt
$42,800

Initial basis
$1,080,000

Depr. Cost
$359,964
$480,060
$159,948
$80,028

Derepciation tax
savings
$125,987
$168,021
$55,982
$28,010