Question

Mr. Jones of Montana Farms is thinking about investing in a new J-Wing four-row Beet harvester. He is currently operating two two-row harvesters and the new harvester would replace both of the current potato harvesters. Mr. Jones 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 beets as much as the old harvesters. The beet processor has agreed to pay a $0.11/sack premium for the reduction in bruising. Mr. Jones operates 1,500 acres of Beets and averages 350 sacks to the acre. Mr. Jones contracts all of his acreage with the processor (so calculate the revenue from the premium on the total acreage). The cost of the new Beet harvester is $165,000. Mr. Jones 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, J-Wing has offered to replace all bearings and chains on the harvester for $22,000 a year starting in year two. Mr. Jones 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%.

A. Show the cash flows for Mr. Jones Investment

B. Calculate the net present value.

C. Is the new beet harvester a profitable investment?

Answer 1

	Year 0	Year 1	Year 2	Year 3	Total
Cost of the Beet Harvestor	165,000
Yearly MACRS depreciation rate for 3 years for 7 year asset		14.29%	24.49%	17.49%
Annual Depreciations		$         23,578.50	$           40,408.50	$      28,858.50	92,846
Tax Rate =25%
Depreciation Tax shield each year @25%=		$           5,894.63	$           10,102.13	$        7,214.63

Written Down Value of Asset after 3 years =	72,155
Salvage value after 3 years	65,000
Capital Loss on salvage	7,155
Tax savings @25% on Capital Loss	1,789
Discount Rate	14%
Total Cultivation area of Mr Jones	1,500	acres
Beetroot production per acre	350	scak/acre
Total Beetroot Production per year	525,000	sacks
Premium per sack for reduced bruising	$                    0.11
Annual Premium =525000*0.11=	$          57,750.00
Annual savings from elimination of tractor & operator	$                29,000

	NPV Caluclation	Year 0	Year 1	Year 2	Year 3
a	Initial Investment	(165,000)
	Cash flow from Operations
	Annual premium earning		57,750	57,750	57,750
	Addd; Annual savings from Trackor & Operator cost reduction		29,000	29,000	29,000
	Less : Reapiring cost from year 2			22,000	22,000
	Operating Income		86,750	64,750	64,750
	Tax @25%		21,688	16,188	16,188
	After Tax Income		65,063	48,563	48,563
	Add: Tax shield from Depreictaion		5,894.63	10,102.13	7,214.63
b	Total Cash flow from Operations		70,957.13	58,664.63	55,777.13
	Terminal Cash flow
	Salvage value				65,000
	Tax savings from Capital Loss				1,789
c	Total Terminal Value				66,789
d	Free Cash fow from Replacement=a+b+c	(165,000)	70,957	58,665	122,566	Ans A
e	PV Factor @1/1.14^n=	1	0.8772	0.7695	0.6750
f	PV of FCF =	(165,000)	62,244	45,142	82,732
g	NPV =Sum of PV of FCF	25,118	Ans B

Ans C.
As the new Harverster replacement results in positive NPV, the new Beet Harvester is a profitable investment.