Mr. Agirich of Aggie Farms is thinking about investing in a center pivot irrigation system to...

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Mr. Agirich of Aggie Farms is thinking about investing in acenter pivot irrigation system to irrigate 100 acres of land. Theirrigation system costs $70,000. Mr. Agirich expects that theirrigation system will increase yield and thus operating receiptsby $15,000 per year but it will cost $4,000 a year to pay forelectricity, maintenance, and additional labor. Mr. Agirich planson keeping the irrigation system for 4 years before replacing itwith a new one and he thinks he can sell it for $50,000 at the endof 4 years. Assume that the Mr. Agirich expects that the inflationrate will be 4% and that operating receipts, operating expenses,and terminal value will increase at the rate of inflation (i.e.,operating receipts, operating expenses and terminal value arestated as real dollars, thus, you must convert them to nominaldollars) . The bank has offered to lend Mr. Agirich $60,000. Theloan will be fully amortized at a 10% interest rate over six years(annual payments). Mr. Agirich anticipates that his marginal taxrate over the next four years will be 20%. The IRS will allow AggieFarms to depreciate the investment using straight?line over 10years. Mr. Agirich requires at least a 13% pre-tax, risk-freereturn on capital and a 2% risk premium on projects of comparablerisk to the irrigation system.
A. Lay out the cash flows for the investment.
B. Calculate the net present value. [NPV=-$1,323.25]
C. Discuss whether or not the irrigation system is a profitableinvestment.
D. Evaluate the financial feasibility of this investment. Wouldthere be a potential liquidity problem if the investment wasprofitable? Explain.

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Incremental receipt in year 1 15000 x 1 4 15600grows at the rate of 4 annuallyIncremental expenses in year 1 4000 x 1 4 4160grows at the rate of 4 annuallySalvage value in year 4 50000 x 1 44 58493Discount rate post tax discount rate Pre tax discount rate x1 tax rate 13 2 x 1 20 12Part A and B Have been answered in the table belowThe rows highlighted in yellow See Answer

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Transcribed Image Text

Mr. Agirich of Aggie Farms is thinking about investing in acenter pivot irrigation system to irrigate 100 acres of land. Theirrigation system costs $70,000. Mr. Agirich expects that theirrigation system will increase yield and thus operating receiptsby $15,000 per year but it will cost $4,000 a year to pay forelectricity, maintenance, and additional labor. Mr. Agirich planson keeping the irrigation system for 4 years before replacing itwith a new one and he thinks he can sell it for $50,000 at the endof 4 years. Assume that the Mr. Agirich expects that the inflationrate will be 4% and that operating receipts, operating expenses,and terminal value will increase at the rate of inflation (i.e.,operating receipts, operating expenses and terminal value arestated as real dollars, thus, you must convert them to nominaldollars) . The bank has offered to lend Mr. Agirich $60,000. Theloan will be fully amortized at a 10% interest rate over six years(annual payments). Mr. Agirich anticipates that his marginal taxrate over the next four years will be 20%. The IRS will allow AggieFarms to depreciate the investment using straight?line over 10years. Mr. Agirich requires at least a 13% pre-tax, risk-freereturn on capital and a 2% risk premium on projects of comparablerisk to the irrigation system.A. Lay out the cash flows for the investment.B. Calculate the net present value. [NPV=-$1,323.25]C. Discuss whether or not the irrigation system is a profitableinvestment.D. Evaluate the financial feasibility of this investment. Wouldthere be a potential liquidity problem if the investment wasprofitable? Explain.