Question

The Cornchopper Company is considering the purchase of a new harvester.

The new harvester is not expected to affect revenue, but operating expenses will be reduced by $13,200 per year for 10 years.

The old harvester is now 5 years old, with 10 years of its scheduled life remaining. It was originally purchased for $68,000 and has been depreciated by the straight-line method.

The old harvester can be sold for $21,200 today.

The new harvester will be depreciated by the straight-line method over its 10-year life.

The corporate tax rate is 22 percent.

The firm’s required rate of return is 13 percent.

The initial investment, the proceeds from selling the old harvester, and any resulting tax effects occur immediately.

All other cash flows occur at year-end.

The market value of each harvester at the end of its economic life is zero.

  

Determine the break-even purchase price in terms of present value of the harvester. This break-even purchase price is the price at which the project’s NPV is zero.

Answer 1

	working	1	2	3	4	5	6	7	8	9	10	Total
cash flow:
operating cost saved		$         13,200	$         13,200	$         13,200	$         13,200	$         13,200	$         13,200	$         13,200	$         13,200	$         13,200	$         13,200
-depreciation	68000/10 for 5 yrs	$          -6,800	$          -6,800	$          -6,800	$          -6,800	$          -6,800
EBIT		$            6,400	$            6,400	$            6,400	$            6,400	$            6,400	$         13,200	$        13,200	$         13,200	$         13,200	$         13,200
- Income tax	EBIT* 22%	$          -1,408	$          -1,408	$          -1,408	$          -1,408	$          -1,408	$          -2,904	$          -2,904	$          -2,904	$          -2,904	$         -2,904
PAT		$            4,992	$            4,992	$            4,992	$            4,992	$            4,992	$         10,296	$         10,296	$         10,296	$         10,296	$         10,296
+dep.		$            6,800	$            6,800	$            6,800	$            6,800	$            6,800	$                   -	$                   -	$                   -	$                   -	$                   -
Operating cash flow		$         11,792	$         11,792	$         11,792	$         11,792	$         11,792	$         10,296	$         10,296	$         10,296	$         10,296	$         10,296
Discount factor	(1/(1+r%)^n	1/(1+13%)^1	1/(1+13%)^2	1/(1+13%)^3	1/(1+13%)^4	1/(1+13%)^5	1/(1+13%)^6	1/(1+13%)^7	1/(1+13%)^8	1/(1+13%)^9	1/(1+13%)^10
DF		0.885	0.783	0.693	0.613	0.543	0.480	0.425	0.376	0.333	0.295
Discounted cash flow (DF*cash flow)		$   10,435.40	$      9,234.87	$      8,172.45	$      7,232.25	$      6,400.23	$      4,945.36	$      4,376.42	$      3,872.94	$      3,427.38	$      3,033.08	$     41,475.19

• Here the operating expenses of $13200 ae saved for 10 yrs
• Depreciation of 5 yrs are only left
• Income tax of 22% is pplied
• Cost of capital is 13%

Now we calculated that the present value of these cash flow is= $61,130

And we can sell the machinery today we will receive =$21,200

So the net benefit by this machine = 61130+21200 = $82330

Now, NPV= benefit- cost

If the NPV =0

The cost = benefit =$82330.

So the break even purchase price = $82330