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STC & Tweety, Tweety, LLP, own and operate a canary farm.

STC & Tweety are considering replacing their canary barn. The current (old) barn has a book value of $60,000 and could be sold today for $45,000. Alternatively, the current barn could be used for the next three years, after which it could be sold for $3,000.

If STC & Tweety decide to keep using the old barn then they anticipate spending $10,000 to fix (repair) the barn at the end of the first year. These costs are considered a routine maintenance expense and will not increase the barns book value.

A new canary barn would cost $180,000, but it would save STC & Tweety $70,000 in before-tax operating costs for each of the next three years. In addition, after the third year STC & Tweety could sell the new barn to a local farmer for $5,000.

STC & Tweety depreciate all of their assets using straight-line depreciation and zero assumed salvage value (i.e., the salvage value assumed for depreciation purposes does not equal the actual sales value of the end of each barns useful life). Their required rate of return (cost of capital) is 10%, and their tax rate is 30%. Assume all operating cash flows (including taxes paid) occur at year end. Required:

a. Draw a time line that shows all of the cash flows associated with keeping the old bard and buying the new barn.

b. Using NPV analysis, how much does STC & Tweety save (or lose) in todays dollars by investing in the new barn? c. Should STC & Tweety invest in the new barn?

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