Mr. Agirich of Aggie Farms is thinking about investing in a center pivot irrigat

Question

Mr. Agirich of Aggie Farms is thinking about investing in a center pivot irrigation system to irrigate 100 acres of land. The irrigation system costs $70,000. Mr. Agirich expects that the irrigation system will increase yield and thus operating receipts by $15,000 per year but it will cost $4,000 a year to pay for electricity, maintenance, and additional labor. Mr. Agirich plans on keeping the irrigation system for 4 years before replacing it with a new one and he thinks he can sell it for $50,000 at the end of 4 years. Assume that the Mr. Agirich expects that the inflation rate 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 are stated as real dollars, thus, you must convert them to nominal dollars). The bank has offered to lend Mr. Agirich $60,000. The loan will be fully amortized at a 10% interest rate over six years (annual payments). Mr. Agirich anticipates that his marginal tax rate over the next four years will be 20%. The IRS will allow Aggie Farms to depreciate the investment using straight-line over 10 years. Mr. Agirich requires at least a 13% pre-tax, risk-free return on capital and a 2% risk premium on projects of comparable risk to the irrigation system.

What is the present value of tax savings from depreciation?

$70,000

$29,347

$4,252

$35,077

-$1,323

None of the above

What is the loan balance at the end of the third year?

$43,669

$34,259

$52,224

$23,909

None of the above

What is the tax savings from interest payments in the fourth year?

$685

$3,426

$1,044

$873

None of the above

What is the Net Cash Flow after debt flows at the end of the second year?

-$2,024

$29,888

-$1,604

$1,813

None of the above

Financial Feasibility is not a problem?

True

False

$70,000

$29,347

$4,252

$35,077

-$1,323

None of the above

What is the loan balance at the end of the third year?

$43,669

$34,259

$52,224

$23,909

None of the above

What is the tax savings from interest payments in the fourth year?

$685

$3,426

$1,044

$873

None of the above

What is the Net Cash Flow after debt flows at the end of the second year?

-$2,024

$29,888

-$1,604

$1,813

None of the above

Financial Feasibility is not a problem?

True

False

Explanation / Answer

1.

2.

3.

4 & 5

4. Answer : None of the above

5. Since NPV of the project is negative it is not feasible. Answer: False

Pre Tax Risk Free Return Rate 13% Risk Premium 2% Pre Tax Rate 15% After Tax Rate (15*(1-0.2) 12% Cost of Investment (A) 70000 No of years (B) 10 Depreciation per year (C=A/B) 7000 Tax Rate (D) 20% Tax Savings per year (E=C*D0 1400 PV Annuity Factor= (1-(1+r)^-n)/r where r= discounting rate n= no of years PV Annuity Factor= (1-(1+0.12)^-4)/0.12                            3.04 PV of Tax Savings = 1400*3.04 =                          4,252

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