Question 1 - A farm owner is considering replacing his obsolete tractor with one of two new state-of-the-tractors. This new machine would cost $125,000 and would have a ten-year useful life. Unfortunately, the new machine would have no salvage value but would result in annual cost savings of $23,000 per year. The current old tractor can be sold now for $10,000. The farm owner's Cost of Capital is 10%.
The farm owner uses the straight line method of depreciation (this depreciation information is needed only for calculating the "Simple Rate of Return" in Question 2).
a) Calculate the Net Present Value of replacing the tractor .
b) Based on this method of comparison, would you recommend replacing the tractor? Why?
Question 2 - Based on the above information for Question #2 and your solution to that question, calculate the following associated with replacing the tractor:
c) The Profitability Index
d) The Payback Period
e) Simple Rate of Return