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 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 at 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

Cash flow of investment in year 0 = $(12,000,000) x 1.000 = $(12,000,000)

Present Value of annual operating cash flow from operations is found using the present value factor for an annuity:

= $1,800,000 x PVAF (10 years, 10%)

= $1,800,000 x 6.1446 (rounded off)

= $11,060,280

Present value of salvage value and tax on capital gain in year 10 is:

= $5,000,000 - (2,000,000 x 0.35) x PVF (10 Years, 10%)

= $(5,000,000 - 700,000) x 0.3855

= $4,300,000 x 0.3855 (rounded off)

= $1,657,650

Therefore, NPV of the farm = $(12,000,000) + $11,060,280 + $1,657,650

= $717,930

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