A farm must decide whether or not to purchase a new tractor. The tractor will reduce costs by $2,000 in the first year, $2,500 in the second and $3,000 in the third and final year of usefulness. The tractor costs $9,000 today, while the above cost savings will be realized at the end of each year. If the interest rate is seven percent, what is the net present value of purchasing the tractor?

Net present value of purchasing tractor is -$2498.35.

Explanation:

Tractor Cost = $9,000

PV of Year 1 saving = $2,000 ( 1 + 0.07 )^-1 = $1,869.16

PV of Year 2 saving = $2,500 ( 1 + 0.07 )^-2 = $2,183.60

PV of Year 1 saving = $3,000 ( 1 + 0.07 )^-3 = $2,448.89

Net Present Value = ($9,000) + $1,869.16 +  $2,183.60 + $2,448.89

Net present value = ($2498.35)

this business is a price setter.

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