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 $12.10  million. This investment will consist of $2.50   million for land and $9.60  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 $5.15  million, $2.25  million above book value. The farm is expected to produce revenue of $2.00  million each year, and annual cash flow from operations equals $1.86  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

duration = 10 years
initial funds (millions) = 12.1
final funds (millions) = 5.15
net expenditure (millions) = 6.95
operating cash flow (per year) (millions) = 1.86
income after tax = 1.86 * (1 - 0.35) = 1.86 * 0.65 =1.209 = 1.21
We can now calculate net present value
The time series is a geometric series of 10 terms with initial value 1 and ratio r = 1/(1 + 0.1) = 0.91
(the 0.1 value represents a discount rate of ten percent).
We can then apply summation formula
NPV (millions) = sum(i = 0, 9) 1.22 * r^i = 1.21 (1 - r^10)/(1 - r) = 1.22 * 0.61 * 11 = 8.186=8.19
8.19 > 6.88
project should be accepted

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