11.20 FCF and NPV for a project: Archer Daniels Midland Company is considering b

Question

11.20 FCF and NPV for a project: 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 million. This investment will consist of $2 million for land and $10 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 for a price of $5 million, $2 million above book value. The farm is expected to produce revenue of $2 million each year, and annual cash flow from operations equals $1.8 million. The marginal tax rate is 35 percent, and the appropriate discount rate is 10 percent. Calculate the NPV of this investment.

Explanation / Answer

Answer: Calculation of the NPV:

After tax salvage value=5000000-(2000000*0.35)=4300000

NPV $              718,057 Year Cashflow PV 0     (12,000,000)     (12,000,000) 1          1,800,000          1,636,364 2          1,800,000          1,487,603 3          1,800,000          1,352,367 4          1,800,000          1,229,424 5          1,800,000          1,117,658 6          1,800,000          1,016,053 7          1,800,000              923,685 8          1,800,000              839,713 9          1,800,000              763,376 10          6,100,000          2,351,814 NPV        718,056.93 As NPV is positive the project should be accepted After-tax Salvage value of the assets =          4,300,000

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