Question

Mr. Agirich of Aggie Farms is thinking about investing in a new Double LL four-row potato harvester. He is currently operating two two-row harvesters and the new harvester would replace both of the current potato harvesters. Mr. Agirich expects that he will save $29,000 a year by eliminating one tractor and one operator.   He also expects the new harvester to not bruise the potatoes as much as the old harvesters. The potato processor has agreed to pay a $0.11/sack premium for the reduction in bruising. Mr. Agirich operates 1,500 acres of potatoes and averages 350 sacks to the acre. Mr. Agirich contracts all of his acreage with the processor (so calculate the revenue from the premium on the total acreage). The cost of the new potato harvester is $165,000. Mr. Agirich plans on keeping the harvester for 3 years and he thinks he can sell it for $65,000 at the end of 3 years. To maintain the efficiency of the harvester, Double LL has offered to replace all bearings and chains on the harvester for $22,000 a year starting in year two. Mr. Agirich requires at least a 14% return on capital. IRS will allow to depreciate over 7 years and assume that the salvage is 0. The marginal Tax rate is 25%.

1. Lay out the cash flows for the investment.

1. Calculate the net present value.

1. Discuss whether the potato harvester is a profitable investment.

Answer 1

Therefore, total cash inflow due to replacing old harvesters = 58000 + 57750 + 5893 = $121643

We Know Net present value ( NPV) = Present value of total cash inflow less Present value of total cash outflow

Therefore NPV = $320,893 - $181,928.29

= $144,354.82

Since the NPV is greater than 0 the potato harvester is a profitable investment.

Note: Present value of a dollar can be found in Present value table or you can use the following formula