James of Piedmont Gardens is thinking about investing in a water sprinkler system to irrigate 100 acres of land. The irrigation system costs $70,000. James 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. James 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 James expects that the inflation rate will be 4% and that operating receipts, operating expenses, and terminal value will increase at the rate of inflation (1.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 James $60,000. The loan will be fully amortized at a 10% interest rate over six years (annual payments). James anticipates that his marginal tax rate over the next four years will be 20%. The IRS will allow Piedmont to depreciate the investment using straight-line over 10 years. James 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. 1. Calculate the net present value. 2 Is the sprinkler system going to be a profitable investment? explain D. Would there be a potential liquidity problem if the investment was profitable? Explain. James of Piedmont Gardens is thinking about investing in a water sprinkler system to irrigate 100 acres of land. The irrigation system costs $70,000. James 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. James 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 James expects that the inflation rate will be 4% and that operating receipts, operating expenses, and terminal value will increase at the rate of inflation (1.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 James $60,000. The loan will be fully amortized at a 10% interest rate over six years (annual payments). James anticipates that his marginal tax rate over the next four years will be 20%. The IRS will allow Piedmont to depreciate the investment using straight-line over 10 years. James 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. 1. Calculate the net present value. 2 Is the sprinkler system going to be a profitable investment? explain D. Would there be a potential liquidity problem if the investment was profitable? Explain
