Question

Palmetto Ag. Inc. recently purchased a new harvester. The new machine cost $180,000 and it is expected to generate net after-tax operating cash flows, including depreciation, of $50,000 per year. The machine has a five year expected life. The expected salvage values after-tax adjustments for the machine are given below, and the company’s WACC is 11%. Based on the information below, should the firm operate the machine until the end of its 5 year physical life? If not, then when is its optimal economic life?

                        Year                Annual Net operating cash flow         Salvage Value

                        0                      -$180,000                                            $180,000

                        1                           50,000                                            140,000

                        2                           50,000                                            112,000

                        3                           50,000                                                87,000

                        4                           50,000                                                42,000

                        5                           50,000                                                        0

Answer 1

The Cash flows andNPV are computed as below

Useful life	0	1	2	3	4	5
Year	Cash flows	Cash flows	Cash flows	Cash flows	Cash flows	Cash flows
0	0	-180000	-180000	-180000	-180000	-180000
1		190000	50000	50000	50000	50000
2			162000	50000	50000	50000
3				137000	50000	50000
4					92000	50000
5						50000
NPV	0.00	-8828.83	-3472.12	5799.39	2788.99	4794.85

We see that the NPV is highest at useful life of 3 years. Hence 3 years is the optimum useful life.

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