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

Question

Your firm, Agrico Products, is considering a tractor that would have a cost of $37, 000, would increase pretax operating cash flows before taking account of depreciation by $11, 000 per year, and would be depreciated on a straight-line basis to zero over 5 years at the rate of $7, 400 per year, beginning the first year. (Thus, annual cash flows would be $11, 000 before taxes plus the tax savings that result from $7, 400 of depreciation.) The managers disagree about whether the tractor would 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 do give 5 years of service. The service manager then states that some last for as long as 8 years. 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? Round your answers to two decimal places. Do not round intermediate calculations. Negative amount should be indicated by a minus sign. Tractor NPV if actual life is 5 years. Tractor NPV if actual life is 4 years. Tractor NPV if actual life is 8 years. Tractor's expected NPV.

Explanation / Answer

Yr CF Depreciation Tax Shield (D*t) Net Benefit DF @ 9% DCF if project life 5 yrs DCF if project life 4 yrs DCF if project life 8 yrs 0 -37000 -37000 1    (37,000.00) (37,000.00) (37,000.00) 1 11000 2960 13960 0.917431      12,807.34     12,807.34     12,807.34 2 11000 2960 13960 0.84168      11,749.85     11,749.85     11,749.85 3 11000 2960 13960 0.772183      10,779.68     10,779.68     10,779.68 4 11000 2960 13960 0.708425         9,889.62        9,889.62        9,889.62 5 11000 2960 13960 0.649931         9,073.04        9,073.04 6 11000 11000 0.596267        6,558.94 7 11000 11000 0.547034        6,017.38 8 11000 11000 0.501866        5,520.53 NPV under different scenarios      17,299.53        8,226.49     35,396.38 Expected NPV assuming probablity of 1/3 1/3*17299.53+1/3*8226.49+1/3*35396.38 20307.47

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