Mr. Agirich of Aggie Farms is thinking about investing in a center pivot irrigation system to irrigate 100 acres of land. The irrigation system costs $70,000. Mr. Agirich 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. Mr. Agirich 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 Mr. Agirich expects that the inflation rate will be 4% and that operating receipts, operating expenses, and terminal value will increase at the rate of inflation (i.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 Mr. Agirich $60,000. The loan will be fully amortized at a 10% interest rate over six years (annual payments). Mr. Agirich anticipates that his marginal tax rate over the next four years will be 20%. The IRS will allow Aggie Farms to depreciate the investment using straightline over 10 years. Mr. Agirich 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. What is the after-tax risk adjusted discount rate?

a. 15%

b. 12%

c. 13%

d. 10.4%

e. None of the above

2. What is the present value of the after-tax net returns?

a. $70,000

b. $29,347

c. $4,252

d. $35,077

e. -$1,323

f. None of the above

3. What is the present value of tax savings from depreciation?

a. $70,000

b. $29,347

c. $4,252

d. $35,077

e. -$1,323

f. None of the above