Question

Hummer Seed Company

You have been hired as the financial administrator of Hummer Corp., an agricultural seed broker in Northern Utah. Mr. Bullen, the president, has asked you to decide whether or not the company should purchase, at a cost of $450,000, a warehouse and the seed distribution rights for a major seed producer for farms extending from Idaho into Oregon. If the regional sales area is expanded, it is estimated that an investment of $100,000 in working capital will be required. The company expects to operate in the expanded area for 10 years, after which time they anticipate being able to sell the rights for $600,000.

Sales revenues are forecast at $400,000 per year for five years, and $300,000 per year thereafter. Operating expenses will be $50,000 annually, and cost of goods sold amount to 60% of sales.

The full cost of the warehouse and regional sales area will be depreciated on a straight line basis over 10 years.

If the firm acquires the assets in question, it will be able to dispose of certain fixed assets that it presently owns. These have a net book value of $40,000, a remaining (straight line) depreciable life of 4 years, and could be sold for $30,000.

Mr. Bullen estimates the required rate of return for Hummer to be 14 percent. Assume a tax rate of 30%. .

Complete a NPV and IRR analysis on the project

Answer 1

Tax rate		30%
	Year-0	Year-1-8
Revenue		400,000
Cost		240,000
Contribution		160,000
Less: operating expense		50,000
Less: Depreciation-450000/10		45,000
Profit before tax		65,000
Tax		19,500
Profit After Tax		45,500
Add Depreciation		45,000
Cash Profit After tax		90,500
		Rights	Fixed asset
Cost of macine		450,000	40,000
Depreciation		450,000	-
WDV		-	40,000
Sale price		600,000	30,000
Profit/(Loss)		600,000	(10,000)
Tax		180,000	(3,000)
Sale price after tax		420,000	33,000
Calculation of NPV
						14.00%
Year	fixed asset	Captial	Working captial	Operating cash	Annual Cash flow	PV factor	Present values
0	33,000	(450,000)	(100,000)		(517,000)	1.000	(517,000)
1			-	90,500	90,500	0.877	79,386
2			-	90,500	90,500	0.769	69,637
3			-	90,500	90,500	0.675	61,085
4			-	90,500	90,500	0.592	53,583
5			-	90,500	90,500	0.519	47,003
6			-	90,500	90,500	0.456	41,231
7			-	90,500	90,500	0.400	36,167
8			-	90,500	90,500	0.351	31,726
9			-	90,500	90,500	0.308	27,829
10		420,000	100,000	90,500	610,500	0.270	164,679
					Net Present Value		95,325
Calculation of IRR
			17.00%		18.00%
Year		Total cash flow	PV factor @ 17%	Present values	PV factor @ 18%	Present values
0		(517,000)	1.000	(517,000)	1.000	(517,000)
1		90,500	0.855	77,350	0.847	76,695
2		90,500	0.731	66,111	0.718	64,996
3		90,500	0.624	56,506	0.609	55,081
4		90,500	0.534	48,295	0.516	46,679
5		90,500	0.456	41,278	0.437	39,558
6		90,500	0.390	35,280	0.370	33,524
7		90,500	0.333	30,154	0.314	28,410
8		90,500	0.285	25,773	0.266	24,076
9		90,500	0.243	22,028	0.225	20,404
10		610,500	0.208	127,007	0.191	116,645
				12,783		(10,932)
		IRR	=Lower rate + Difference in rates*(NPV at lower rate)/(Lower rate NPV-Higher rate NPV)
		IRR	'=17%+ (18%-17%)*(12783.0/(12783.0-(-10931.)
			17.539%