Question: Your firm Agrico Products is considering the purchase of a

Your firm, Agrico Products, is considering the purchase of a tractor that has a net cost of $72,000, will increase pretax operating cash flows before taking account of depreciation effects by $24,000 per year, and will be depreciated on a straight line basis to $0 over five years at the rate of $14,400 per year, beginning the first year. (Annual cash flows will be $24,000 before taxes plus the tax savings that result from $14,400 of depreciation.) The board of directors is having a heated debate about whether the tractor actually will last five years. Specifically, Joan Lamm insists that she knows of some tractors have lasted only four years. Alan Grunewald agrees with Lamm, but he argues that most tractors do provide five years of service. Judy Maese says she has known some to last for as long as eight years.
Given this discussion, the board asks you to prepare a scenario analysis to ascertain the importance of the uncertainty about the tractor’s life span. Assume a 40 percent marginal tax rate, a $0 salvage value, and a required rate of return of 10 percent.

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  • CreatedNovember 24, 2014
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