Your firm, Agrico Products, is considering a tractor that would have a cost of $37,000, would...

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Your firm, Agrico Products, is considering a tractor that wouldhave a cost of $37,000, would increase pretax operating cash flowsbefore taking account of depreciation by $12,000 per year, andwould be depreciated on a straight-line basis to zero over 5 yearsat the rate of $7,400 per year, beginning the first year. (Thus,annual cash flows would be $12,000 before taxes plus the taxsavings that result from $7,400 of depreciation.) The managers arehaving a heated debate about whether the tractor would actuallylast 5 years. The controller insists that she knows of tractorsthat have lasted only 4 years. The treasurer agrees with thecontroller, but he argues that most tractors actually do give 5years of service. The service manager then states that some lastfor as long as 8 years.
Assume that if the tractor only lasts 4 years, then the firmwould receive a tax credit in Year 4 because the tractor's salvagevalue at that time is less than its book value. Under thisscenario, the firm would not take depreciation expense in Year5.
Given this discussion, the CFO asks you to prepare a scenarioanalysis to determine the importance of the tractor's life on theNPV. Use a 40% marginal federal-plus-state tax rate, a zero salvagevalue, and a 9% WACC. Assuming each of the indicated lives has thesame probability of occurring (probability = 1/3), what is thetractor's expected NPV?
Do not round intermediate calculations. Negative values, if any,should be indicated by a minus sign. Round your answers to thenearest cent.
Tractor's NPV if actual life is 5 years.
$

Tractor's NPV if actual life is 4 years.
$

Tractor's NPV if actual life is 8 years.
$

Tractor's expected NPV.
$

Answer & Explanation Solved by verified expert

3.8 Ratings (620 Votes)

First we will calculate annual cash inflowa Tractors NPVif actual life is 5 yearCalculate Present value of cash inflow for 5 See Answer

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Your firm, Agrico Products, is considering a tractor that wouldhave a cost of $37,000, would increase pretax operating cash flowsbefore taking account of depreciation by $12,000 per year, andwould be depreciated on a straight-line basis to zero over 5 yearsat the rate of $7,400 per year, beginning the first year. (Thus,annual cash flows would be $12,000 before taxes plus the taxsavings that result from $7,400 of depreciation.) The managers arehaving a heated debate about whether the tractor would actuallylast 5 years. The controller insists that she knows of tractorsthat have lasted only 4 years. The treasurer agrees with thecontroller, but he argues that most tractors actually do give 5years of service. The service manager then states that some lastfor as long as 8 years.Assume that if the tractor only lasts 4 years, then the firmwould receive a tax credit in Year 4 because the tractor's salvagevalue at that time is less than its book value. Under thisscenario, the firm would not take depreciation expense in Year5.Given this discussion, the CFO asks you to prepare a scenarioanalysis to determine the importance of the tractor's life on theNPV. Use a 40% marginal federal-plus-state tax rate, a zero salvagevalue, and a 9% WACC. Assuming each of the indicated lives has thesame probability of occurring (probability = 1/3), what is thetractor's expected NPV?Do not round intermediate calculations. Negative values, if any,should be indicated by a minus sign. Round your answers to thenearest cent.Tractor's NPV if actual life is 5 years.$ Tractor's NPV if actual life is 4 years.$ Tractor's NPV if actual life is 8 years.$ Tractor's expected NPV.$