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SCENARIO ANALYSIS Your firm, Agrico Products, is considering a tractor that would have a cost of $36,000, would increase pretax operating cash flows before taking account of depreciation by $12,000 per year, and would be depredated on a straight-line basis to zero over 5 years at the rate of $7,200 per year beginning the first year. (Thus, annual cash flows would be $12,000 before taxes plus the tax savings that result from $7,200 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 10% WACC. Assuming each of the indicated lives has the same probability of occurring (probability = 1/3), what is the tractor’s expected NPV? (1-lint: Use the 5-year straight-line depredation for all analyses, and ignore the MACRS half-year convention for this problem.)

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Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
Publisher: Cengage Learning
ISBN: 9781285867977
BuyFind

Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
Publisher: Cengage Learning
ISBN: 9781285867977

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Chapter
Section
Chapter 12, Problem 18P
Textbook Problem

SCENARIO ANALYSIS Your firm, Agrico Products, is considering a tractor that would have a cost of $36,000, would increase pretax operating cash flows before taking account of depreciation by $12,000 per year, and would be depredated on a straight-line basis to zero over 5 years at the rate of $7,200 per year beginning the first year. (Thus, annual cash flows would be $12,000 before taxes plus the tax savings that result from $7,200 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 10% WACC. Assuming each of the indicated lives has the same probability of occurring (probability = 1/3), what is the tractor’s expected NPV? (1-lint: Use the 5-year straight-line depredation for all analyses, and ignore the MACRS half-year convention for this problem.)

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