Question

Sheridan Company is considering buying a new farm that it plans to operate for 10 years. The farm will require an initial investment of $11.80 million. This investment will consist of $2.70 million for land and $9.10 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 $5.05 million, which is $2.50 million above book value. The farm is expected to produce revenue of $2.00 million each year, and annual cash flow from operations equals $1.80 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.)

Answer 1

First of all let us calculate depreciation

here book value at end of 10 year = Selling price - profit = 5.05 million - 2.5 million = 2.55 million

Annual depreciation = Cost - book value/ No of years

=(11.8-2.55)/10

=0.925 million

Now , Annual tax expense

= (Annual sales - Annual depreciation) x 35%

=(2 million - 0.925 million) x 35%

=0.37625 million

Annual post tax cash flow from operation = 1.8 million - 0.37625 million = 1.42375 million

Post tax salvage value = 5.05 million - (2.5 million*35%)

=5.05 million - 0.875

=4.625 million

Now let us calculate NPV

NPV = Annual post tax cash flow from operation x PVIFA(10%,10) + Post tax salvage value x PVIF(10%,10) - Initial Investment

={1.42375 x [1-(1/(1+r)^n / r ]} + {4.625 x 1/(1+r)^n} - 11.8

={1.42375 x [1-(1/(1.1)^10 / 0.1 ]} + {4.625 x 1/(1.1)^10} - 11.8

={1.42375 x [1-0.3855 / 0.1 ]} + {4.625 x 0.3855} - 11.8

={1.42375 x [0.6144 / 0.1 ]} + 1.7831 - 11.8

=(1.42375 x 6.144567) + 1.7831 -11.8

=8.7483 + 1.7831 -11.8

= -1.27 million

Since NPV is negative, project should not be selected