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

Cornchopper has
hired you to determine the economic break-even purchase price of the harvester. Base your
analysis on the following facts:

 The new harvester is not expected to affect revenues, but pretax operating expenses
will be reduced by $8,000 per year for ten years.
 The old harvester is now 5 years old with 10 years of its scheduled life remaining. It
was originally purchased for $45,000 and has been depreciated by the straight-line
method.
 The old harvester can be sold for $10,000 today
 The new harvester will be depreciated by the straight-line method over its 10-year
life.
 The corporate tax rate is 40 percent.
 The project’s required return is 12 percent.
 The initial investment, the proceeds from selling the old harvester and any resulting
tax effects occur immediately. Capital gains or losses are taxed at the corporate of 40
percent when they are realized.
 All other cash flows occur at the year-end.
 The market value of each harvester at the end of its economic life is zero.

From Corporate Finance by Ross Westerfield Jaffe 7th Ed. page 229 – 230

Depreciation and Book Value Calculations

Old Equipment:

45,000  0
Depreciation =  3,000
15
Book Value = 45,000 – (5)(3,000) = 30,000

New Equipment:

Pr ice BE  0
Depreciation = = .1PriceBE
10

Initial Investment:

New Equip: -PriceBE

Old Equip: 18,000 =10,000 – 0.40(10,000 – 30,000)
CF0 = -PriceBE + 18,000

OCF:

OCF = (8,000)(1 – .40) + (.1PriceBE - 3,000)(0.40)

= (8,000)(0.60) + .04PriceBE - 1,200
= 3,600 + .04PriceBE

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Non OCF:

SV =0
Return NWC = 0

Total =0

NPV

0 = -PriceBE + 18,000 + (3,600 + .04PriceBE)(PVIFA10,12%)

PriceBE = 18,000 + (3,600)( PVIFA10,12%) + (.04PriceBE)(PVIFA10,12%)

PriceBE = 18,000 + (3,600)( PVIFA10,12%) + PriceBE[(.04)(PVIFA10,12%)]

N 10 N 10
I 12% I 12%
Cpt PV 20,340.80 Cpt 0.2260
PV
Pmt 3,600 Pmt 0.04
FV 0 FV 0

PriceBE = 18,000 + 20,340.80 + 0.226PriceBE

0.774PriceBE = 38,340.80

PriceBE = 49,536.49

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