Unit 6 Group Projects is based on Chapter 14
Answer questions in the following, and provide detailed calculations where needed.
Group project 6: Scenario Analysis (E, p538, #13-30)
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 tractors life span. Assume a 40 percent marginal tax
rate, a $0 salvage value, and a required rate of return of 10 percent. (Hint: Here, straight line
depreciation is based on the MACRS class life of the tractor and is not affected by the actual life.
Also, ignore the half-year convention for this problem.)
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