A farmer is thinking about investing in a center pivot irrigation system to irrigate 80 acres of land in Fresno. With an irrigation system, operating expenses would increase by $75 per acre due to electricity, maintenance and additional labor. It is estimated that the irrigation will increase yields and thus operating receipts by $150 per acre. The cost for drilling a well would be $8,200 and the cost for the center pivot irrigation system would be $31,000. The irrigation system would be mile long and would irrigate 80 acres. Suppose that the farmer wants to evaluate this investment over a five-year period of time. The farmer believes that if he sold the farm in five years, the irrigation system would add $31,000 to the sale price. The farmer anticipates that his marginal tax rate over the next six years will be 15%. The IRS will allow the farmer to depreciate the investment using straight line over 15 years. Assume that the terminal value of this investment is $31,000 at the end of five years. The farmer requires a 10% return to capital (pretax).

Calculate the Initial Cost

a. $39,200

b. $22,800

c. $31,000

d. $8,200

Calculate the after-tax net returns

a. $10,200

b. $12,000

c. $5,100

d. $75

Calculate the tax savings from depreciation

a. $310

b. $392

c. $2,221

d. $2,613

Calculate the after-tax terminal value

a. $29,450

b. $33,320

c. $26,350

d. $30,270

Suppose that the discount rate is 8.5%. Using information from your answers above, what is the NPV for the investment?

a. $1,835.39 b. $4,680.59

c. $2,572.93 d. $4,104.83

Suppose an investment has a life of 3 years, an after-tax discount rate of 10%, and tax savings from depreciation of 1,067 per year. The present value of tax savings from depreciation is $3,201. true fales

If the net present value is positive then you have made an unacceptable investment.

True

False

If the net present value is negative then you have made an acceptable investment.

True

False

Suppose that the initial cost of an investment is $310,000, the present value of tax saving from depreciation is $10,510.53, and the present value after tax terminal value is $185,573.74. There is a pretax discount rate of 16% while the marginal tax rate is 28%. What is the break even after-tax net revenue price?

		$47,038
		$57,483
		$63,292
		$63,847