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 $2.40   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 $5.04  million, $2.41  million above book value. The farm is expected to produce revenue of $2.09  million each year, and annual cash flow from operations equals $1.95  million. The marginal tax rate is 35  percent, and the appropriate discount rate is 9   percent. Calculate the NPV of this investment.

Explanation / Answer

duration = 10 years

initial funds (millions) = 12
final funds (millions) = 5.04

net expenditure (millions) = 6.96

operating cash flow (per year) (millions) = 1.95
income after tax = 1.95 * (1 - 0.35) = 1.95 * 0.65 =1.27

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 + 0.09) = 0.917
(the 0.09 value represents a discount rate of nine percent).

We can then apply summation formula

NPV (millions) = sum(i = 0, 9) 1.27 * r^i = 1.27 (1 - r^10)/(1 - r) = 8.86 Millions

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