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 $12.1 million. This investment will consist of $2.3 million for land and $9.80 million for trucks and other equipment. The land, all trucks, and all other equipment are expected to be sold at the end of 10 years for a price of $5.1 million, which is $2.0 million above book value. The farm is expected to produce revenue of $2.02 million each year, and annual cash flow from operations equals $1.90 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 to 4 decimal palces, e.g. 0.5275 and final answer to 2 decimal places, e.g. 15.25.)

NPV

$

The project should be

acceptedrejected

.

Answer 1

Cash outflow in year 0 =  initial investment = $12.1 million

Cash inflow in years 1 to 9 = operating cash flow = $1.90 million

Cash inflow in year 10 = operating cash flow + after-tax sale price

after-tax sale price = sale price - (excess of sale price over book value * tax rate)

after-tax sale price = $5.1 million - ($2 million * 35%) = $4.40 million

Cash inflow in year 10 = $1.90 million + $4.40 million = $6.30 million

NPV = sum of present values of all cash flows

Present value of each cash flow = cash flow / (1 + discount rate)ⁿ

where n = number of years after which the cash flow occurs

NPV = $1,271,067.97

The project should be accepted because the NPV is positive