Question

Sunland 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 $2.55 million for land and $9.45 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 $5.00 million, which is $2.35 million above book value. The farm is expected to produce revenue of $2.05 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 10 percent. Calculate the NPV of this investment. (Do not round factor values. Round final answer to 2 decimal places, e.g. 15.25.)

NPV

The project should be

Answer 1

Particulars Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 (12,000,000) Upfront Investment After tax Annual Cash flow from operation Saving in tax due to depreciation After tax cash flow on sale Total cash flow Discount factor Discounted savings 1,267,500 1,267,500 1,267,500 1,267,500 1,267,500 327,250 327,250 327,250 327,250 327,250 (12,000,000) 1,594,750 1,594,750 1,594,750 1,594,750 1,594,750 1 0.909091 0.826446 0.751315 0.683013 0.620921 (12,000,000) 1,449,772.73 1,317,975.21 990,214.28 1,198,159.28 1,089,235.71 Particulars Year 6 Year 7 Year 8 Year 9 Year 10 NPV Upfront Investment Annual Cash flow from operation Saving in tax due to depreciation After tax cash flow on sale Total Cash flow 1,267,500 1,267,500 1,267,500 1,267,500 1,267,500 327,250 327,250 327,250 327,250 327,250 4,177,500 1,594,750 1,594,750 1,594,750 1,594,750 5,772,250 Discount factor 0.466507 0.385543 0.564474 0.513158 0.424098 Discounted cashflow 743,962.64 (590,344.52) 900,195 818,358.91 676,329.68 2,225,452.25 NPV Dicounted Cash inflow - Discounted Cash outflow

NPV = $(590,344.52)

The project should be Rejected.

Because it does not give the required return of 10%

Working:

Book value of the asset $5 million- $2.35 million $2.65 million Saving in tax due to depreciation Total value of the asset 12,000,000 Book Value at the end of 10 years Depreciable amount Depreciation (9.35 million/10) (x) Tax rate Saving in tax due to depreciation (x*35%) (2,650,000) 9,350,000 935,000 35% 327,250

After tax cash flow on sale Sale Value (a) Book Value Profit on sale Tax @ 35% on profit (b) Cash flow after tax (a b) 5,000,000 (2,650,000) 2,350,000 822,500 4,177,500

After tax Annual Cash flow from operation Annual Cash flow from operation 1,950,000 Tax Rate 35% Tax 682,500 Cash flow after tax 1,267,500

Discount factor Formula :

$DF=\frac{1}{(1+i)^n}$

Where i = required rate of return

n= number of periods