Existing Machine

Twynstra was using a CaseIH 2366 with a 25-foot grain head. He had bought the machine in 1999, and had just completed the payments for the machine. He estimated the existing machine required repairs of

$27,000 immediately and $10,000 in the second year. In addition to the major repairs, Twynstra recognized that combines typically required about $4,000 per year of maintenance. He also felt that after another four years, the CaseIH 2366 would no longer be functional, and he would need to invest in new machinery at that time. After the four years, he assumed he would get $75,000 as a trade-in value.

New Machine

Twynstra was also considering buying a new CaseIH 2388. He planned to put the existing 25-foot grain head on the machine even though it did have the capability to support a 30-foot grain head.

The new machine's cost was $267,000, but the dealer offered a $152,000 trade-in value for the older machine.TwynstrawouldbeforcedtofinancetherestofthepurchasethroughabankorthroughtheFarm Credit Corporation. He had been offered a 5.9 per cent financing rate over a four-year term. The expected payments were $16,347 with two payments per year. At the end of the four years, Twynstra would own themachine.

The new machine offered approximately a 15 per cent productivity increase over the existing model. This would reduce the usage hours each year on the machine from 440 hours to 380. Twynstra felt that the productivity improvement could lead to a variety of savings, such as reduced labor, fuel and maintenance costs. He currently paid his workers $20 per hour, including benefits. Fuel costs per hour had been estimated at $22.96.⁵The maintenance costs were expected to decrease yearly to $2,000, but for the first year and a half, the new machinery would be under warranty. Twynstra recognized that the new machinery would qualify for a capital cost allowance of 30 per cent per year. Twilight Acre Farms' tax rate was 21 per cent, and Twynstra expected that, in four years, the machine would have a trade-in of approximately$140,000.

Twynstra also felt there were some intangible benefits to owning the new equipment. His workers took pride in using new equipment and would potentially perform better. In addition, he recognized that TwilightAcresrentedalargepercentageofland,andhefeltnewequipmentaffectedthelandlord'sopinion of the operation. Twynstra also recognized that some years the harvest could be so great that the increased capacity could be required. He could not estimate the actual benefits but recognized that during these years, the extra capacity was worth approximately $35 per acre,⁶depending on the crop. He knew that the customworkcouldbeminimalbutwonderedhowmanyhourshewouldneedtojustifytheinvestment.

Despite the intangible upsides, Twynstra was concerned about increasing the level of debt in the business. Debt was becoming a major issue in many mid-sized farms, and he did not want to take on additional financingunlessrequired.Also,Twynstracouldnotbecertainabouttheimprovedperformanceasthenew machinery offered few technological improvements. Finally, he wondered whether he could get a 15 per cent return on his investment into themachine.

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. 30% is the corporate tax rate.