The irrigation system that a farmer uses cost $10,000 eight years ago. It will last another 25 years without additional investment. With that system, the farmer produces crops valued at $3,000 per year at a cost of $1,000 per year. A new system could be installed at an immediate cost of $15,000 and it would increase production to $7,000 per year. Operating cost would be $4,500 per year. The revenue and operating cost of both systems do not change over the 25-year investment horizon. The farmer would have to refurbish the new system 12 years after installation at a cost of $5,000.
Assume a 6-percent discount rate. The farmer can sell the old system at today's value of the system's original price. However, the price of the system has increased at the same 6-percent rate but the total depreciation is 40 percent off the final price. Furthermore, the salvage value of the new system will be $2,500 and the salvage price of the old system will be $1,500 at the end of 25 years. Should the farmer replace his existing system?