Archer Daniels Midland Company is considering buying a new farm that it plans to

Question

Archer Daniels Midland Company is considering buying a new farm that it plans to operate for 10 years. The farm will require an initial investment of $12.00 million. This investment will consist of $2.00 million for land and $10.00 million for trucks and other equipment. The land, all trucks, and all other equipment is expected to be sold at the end of 10 years at a price of $5.06 million, $2.01 million above book value. The farm is expected to produce revenue of $2.04 million each year, and annual cash flow from operations equals $1.91 million. The marginal tax rate is 35 percent, and the appropriate discount rate is 10 percent. Calculate the NPV of this investment. (Round intermediate calculations and final answer to 2 decimal places, e.g. 15.25.)

Explanation / Answer

Present value of the 10 annual cashflows can be calculated in Excel as =PV(10%,10,-1.91), where the first parameter is discount rate of 10%, second parameter is 10 years, and last parameter is annual cashflow of 1.91 million.

This is equal to 11.74 million (i.e. $ 11,736,123.17)

When the equipment and land is at the end of 10 years, the tax on capital gains = gains * tax rate = 2.01*35% = 0.7035 million

So cashflow after 10 years = 5.06-0.7035 = $ 4.3565 million

PV of this cashflow today = 4.3565 / (1+10%)^10 = $ 1.6796 million

So NPV = 11.74 + 1.6796 - 12 = 1.42 million = $ 1,415,742.51

As this NPV is positive, this project should be accepted.

Ans: $ 1,415,742.51

Hope this helped ! Let me know in case of any queries.

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