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 $11.90  million. This investment will consist of $2.40   million for land and $9.50  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 $5.17  million, $2.32  million above book value. The farm is expected to produce revenue of $2.04  million each year, and annual cash flow from operations equals $1.90  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

Annual cashflow from operations = $1.90 million. This is valid for years 1-10.

In addition, in the last year (yr 10), we also have an additional cashflow of $5.17 million, which results in a profit of $2.32 million as we are selling the equipment above the book value. Tax on this amount will be 2.32 *35% = 0.812 million. So net cashflow from this sale will be $5.17-0.812 = 4.358 million.

So cashflow in year 10 = 1.90+4.358=6.258 million

NPV = -11.9 + 1.9/1.1^1 + 1.9/1.1^2 + 1.9/1.1^3 + 1.9/1.1^4 + 1.9/1.1^5 + 1.9/1.1^6 + 1.9/1.1^7 + 1.9/1.1^8 + 1.9/1.1^9 + 6.258/1.1^10 = $ 1.45 million

The project should be taken up, as the NPV is positive.

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

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