Exercise 5-1 Net present value method and taxation A fanner is concerned about the modernisation of his equipment. He considers if it makes sense to purchase so-called milking robots. This complicated technical equipment consists of a box regulated by a bar which allows entry of one cow at a time. The teats are automatically addressed by laser rays. The cow is milked exactly as long as there is a steady flow of milk.

This can be beneficial to the health of the herd because the milking log reveals helpful information about each cow. In addition, the farmer can halve his milking time.

Such a milking robot costs € 120,000 and presumably has an estimated economic life of 20 years. Annual repair costs are € 200. Every year the following costs can be saved: € 9,000 for personnel and € 1,000 for veterinary examinations because the cows get ill from inflammation of the udder less frequently. All payments with the exception of the initial outlay occur at the end of the respective year. The discount rate is 5 %.

a) Compute the net present value of the investment, and state whether the investment is worthwhile. Ignore taxation.

b) Now, calculate the net present value using a 30 percent tax rate. How does this change your results?