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The owner of Twilight Acres, Steve Twynstra had to decide whether to purchase a new Machine
or perform significant repairs on the existing machine. The decision had to be made as soon as
possible so that Twynstra could negotiate better and close the deal before the next year’s
harvesting.
The Criteria Steve should consider before making the decision is:
• The capacity of the foot grain required: Existing machinery (CaseIH 2366) has a 25-
foot grain head whereas the new machinery (CaseIH 2388) will also have a 25-foot
grain head but will have an upgradable capacity till 30-foot grain head.
• Maintenance Cost: Existing Machinery has a maintenance cost of $4,000 a year whereas
• Extra expenses: Steve had to decide whether to spend $37,000 on repairs for CaseIH
• Future Value: Steve felt that CaseIH 2366 will not be functional after four years, so he
had to decide whether to spend now on repairs or whether to buy the new machinery.
• Trade-in value: If Steve plans to buy the new machinery, he is being offered a trade-in
value of $152,000 on the other hand if he plans to keep using the existing machinery
Question 2) Perform a Net Present Value calculation for the purchase of the new machine.
Use 15% as the cost of capital. Use $15, 050 as the Present Value of the Tax Shield from
CCA.
Existing machinery
Capital investment = 0
Revenue = $ 75,000
Operating cost = $ 53,000(27,000 of year 1 + 10,000 for year 2 + yearly maintenance for 4
years 4*4000)
Periodic net cash flows = (revenue – operating cost – depreciation) * (1 – tax rate) +
depreciation
Periodic net cash flows = ($75,000 - $53,000 - $28,750) * (1 – 21%) + $28,750 = $23,417.5
Replaced machinery
Periodic net cash flows = ($132,250 - $34,694 - $66,750) * (1 – 21%) + $66,750 = $91,086
Incremental cash flows
Incremental cash flows at time 0 = net investment after replacement – net investment before
replacement
Incremental cash flows in Year 1 to 4 = net annual cash flows after replacement – net annual
NPV = PV factor for 4 years at 0.572% * incremental cash flows (Year 1-4) – incremental
initial investment
NPV = -$121,693.62
IRR = 24.792%
Since the net present value is positive and IRR is way above the hurdle rate, it is feasible to
Question 3) Discuss the pros and cons of purchasing the new machinery.
Question 4) As owner, what would your decision be? Provide necessary support and
justification
As an owner my decision would be to replace the machinery and buy a new machinery. The
justification is as follows: -
NPV (net present value) is positive and IRR is way above the hurdle rate, it is feasible to
Improving capability – due to the improved technology of the machinery it can have a
positive impact on a company’s efficiency, enabling employees to work faster and increase
productivity.
Employees take pride in working with a new machinery and this result in increase
New machinery would make it possible to produce extra in good harvest years and earn
extra profits.
Ownership also gives companies the freedom to determine whether a machine needs
New machinery is less likely to require repairs, which can help your company avoid delays
Improved safety