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 $2.70 million for land and $9.30 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 $5.07 million, $2.00 million above book value. The farm is expected to produce revenue of $2.02 million each year, and annual cash flow from operations equals $1.92 million. The marginal tax rate is 35 percent, and the appropriate discount rate is 10 percent. Calculate the NPV of this investment

Explanation / Answer

duration = 10 years

initial funds (millions) = 12
final funds (millions) = 5.12

net expenditure (millions) = 6.88

operating cash flow (per year) (millions) = 1.87
income after tax = 1.87 * (1 - 0.35) = 1.87 * 0.65 =1.2155 = 1.22

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 = 1.22 (1 - r^10)/(1 - r) = 1.22 * 0.61 * 11 = 8.19

8.19 > 6.88

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