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Your firm, Agrico Products, is considering a tractor that would have a cost of $35,000, would...

Your firm, Agrico Products, is considering a tractor that would have a cost of $35,000, would increase pretax operating cash flows before taking account of depreciation by $12,000 per year, and would be depreciated on a straight-line basis to zero over 5 years at the rate of $7,000 per year, beginning the first year. (Thus, annual cash flows would be $12,000 before taxes plus the tax savings that result from $7,000 of depreciation.) The managers are having a heated debate about whether the tractor would actually last 5 years. The controller insists that she knows of tractors that have lasted only 4 years. The treasurer agrees with the controller, but he argues that most tractors actually do give 5 years of service. The service manager then states that some last for as long as 8 years.

Assume that if the tractor only lasts 4 years, then the firm would receive a tax credit in Year 4 because the tractor's salvage value at that time is less than its book value. Under this scenario, the firm would not take depreciation expense in Year 5.

Given this discussion, the CFO asks you to prepare a scenario analysis to determine the importance of the tractor's life on the NPV. Use a 40% marginal federal-plus-state tax rate, a zero salvage value, and a 9% WACC. Assuming each of the indicated lives has the same probability of occurring (probability = 1/3), what is the tractor's expected NPV? Do not round intermediate calculations. Negative values, if any, should be indicated by a minus sign. Round your answers to the nearest 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. $

Solutions

Expert Solution

NPV if life is 4 Years
Year 0 1 2 3 4
cost of truck -35000
before tax operating cash flow 12000 12000 12000 12000
depreciation -7000 -7000 -7000 -7000
before tax cash flow 5000 5000 5000 5000
tax -40% -2000 -2000 -2000 -2000
after tax cash flow 3000 3000 3000 3000
depreciation 7000 7000 7000 7000
tax credit due to loss of truck at year 4 =(35000-28000)*40% 0 0 0 2800
net operating cash flow = after tax cash flow+depreciation+tax credit -35000 10000 10000 10000 12800
present value of operating cash flow = net operating cash flow/(1+r)^n r = 9% -35000 9174.311927 8416.799933 7721.8348 9067.842702
Net present value =sum of present value of operating cash flow -619.21064
NPV if life is 5 Years
Year 0 1 2 3 4 5
cost of truck -35000
before tax operating cash flow 12000 12000 12000 12000 12000
depreciation -7000 -7000 -7000 -7000 -7000
before tax cash flow 5000 5000 5000 5000 5000
tax -40% -2000 -2000 -2000 -2000 -2000
after tax cash flow 3000 3000 3000 3000 3000
depreciation 7000 7000 7000 7000 7000
tax credit due to loss of truck at year 4 =(35000-28000)*40% 0 0 0 0 0
net operating cash flow = after tax cash flow+depreciation+tax credit -35000 10000 10000 10000 10000 10000
present value of operating cash flow = net operating cash flow/(1+r)^n r = 9% -35000 9174.311927 8416.799933 7721.8348 7084.252111 6499.313863
Net present value =sum of present value of operating cash flow 3896.51263
NPV if life is 8 Years
Year 0 1 2 3 4 5 6 7 8
cost of truck -35000
before tax operating cash flow 12000 12000 12000 12000 12000 12000 12000 12000
depreciation -7000 -7000 -7000 -7000 -7000 0 0 0
before tax cash flow 5000 5000 5000 5000 5000 12000 12000 12000
tax -40% -2000 -2000 -2000 -2000 -2000 -4800 -4800 -4800
after tax cash flow 3000 3000 3000 3000 3000 7200 7200 7200
depreciation 7000 7000 7000 7000 7000 0 0 0
tax credit due to loss of truck at year 4 =(35000-28000)*40% 0 0 0 0 0 0 0 0
net operating cash flow = after tax cash flow+depreciation+tax credit -35000 10000 10000 10000 10000 10000 7200 7200 7200
present value of operating cash flow = net operating cash flow/(1+r)^n r = 9% -35000 9174.311927 8416.799933 7721.8348 7084.252111 6499.313863 4293.12475 3938.647 3613.437
Net present value =sum of present value of operating cash flow 15741.7212
Tractor expected NPV (probability of Year 4 *NPV)+(probability of Year 5*NPV)+(probability of year 8*NPV) (1/3*-619.21)+(1/3*3896.51)+(1/3*15741.72) 6339.7

jeff jeffy answered 1 year ago
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