What is the nominal tax savings from depreciation

Reference no: EM132002840

Question: 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 straight-line 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.

a) What is the annual real pre-tax Net Returns in the third year?

b) What is the annual nominal pre-tax Net Returns in the third year?

c) What is the annual nominal after-tax Net Returns in the third year?

d) What is the nominal tax savings from depreciation?

e) What is the nominal pre-tax terminal value in four years?

f) What is the after-tax nominal terminal value in four years?

g) What is the accumulated depreciation over the four years?

h) What is the after-tax risk adjusted discount rate?

i) What is the present value of the after-tax net returns?

j) What is the present value of tax savings from depreciation?

k) What is the annual loan payment?

l) What is the loan balance at the end of the third year?

m) What is the tax savings from interest payments in the fourth year?

n) What is the Net Cash Flow after debt flows at the end of the second year?

Reference no: EM132002840

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