A farmer is considering replacing a labor-intensive machine system with a more c

Question

A farmer is considering replacing a labor-intensive machine system with a more capital-intensive one. Adopting the new system is estimated to increase machinery operating expenses by about $21000 per year and to replace one hired laborer, whose annual salary is $26,000. The new machiner costs $30,000; however, the trade-in value of the old system is $10,000. Adopting the new machinery will increase annual depreciation by $4000.

Further data indicate an 8-year planning horizon, zero salvage vlaue, a 20% tax rate and a 10% after-tax cost of equity capital. Use the NPV method to evaluate the new machinery system's profitability.

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Explanation / Answer

Annual Operating Depreciation Income Operating Year Savings Cost Before tax Tax @20% EAT Cashflow 1 26000 -21000 -4000 1000 200 800 4800 2 26000 -21000 -4000 1000 200 800 4800 3 26000 -21000 -4000 1000 200 800 4800 4 26000 -21000 -4000 1000 200 800 4800 5 26000 -21000 -4000 1000 200 800 4800 6 26000 -21000 -4000 1000 200 800 4800 7 26000 -21000 -4000 1000 200 800 4800 8 26000 -21000 -4000 1000 200 800 4800 Operating Initial solvage Net pv factor Present Year Cash Cash Value Cashflow at 10% Value 0 -30000 -30000 1.000000 -30000.00 1 4800 4800 0.909091 4363.64 2 4800 4800 0.826446 3966.94 3 4800 4800 0.751315 3606.31 4 4800 4800 0.683013 3278.46 5 4800 4800 0.620921 2980.42 6 4800 4800 0.564474 2709.47 7 4800 4800 0.513158 2463.16 8 4800 10000 14800 0.466507 6904.31 Total 272.72 Net Present value of the project is $272.72

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