Question

# dairy farmer has hired you to analyze the profitability of investing in robotic milkers. The dairy...

dairy farmer has hired you to analyze the profitability of investing in robotic milkers. The dairy farmer provided you with the following data. The cost of the robots and upgrading the facility would be \$703,750. Repair costs would be \$10,000 per year. The robots would save 1,820 hours of labor per year. Assume a labor rate of \$15.00/hr. The robots are also projected to help increase milk production by 4,900 addition cwt per year. Assume a price \$15 per cwt for the milk. The robots and facility can be depreciated over 7 years. The terminal value after year seven is projected to be \$225,000. Assume that the inflation rate will be 2.00% and that operating revenues, operating expenses, and terminal value will increase at the rate of inflation (i.e., operating receipts, operating expenses and terminal value are stated as real dollars, thus, you must convert them to nominal dollars) .

The farmer has arranged financing with Farm Credit Services. They will lend the farmer 80% of the cost of the robots. The loan will be fully amortized at a 4.65% interest rate over 8 years (annual payments). The farmer anticipates that his marginal tax rate over the next five years will be 21%. The farmer requires at least a 5.5% pre-tax, risk-free return on capital and a 2.25% risk premium on projects of comparable investments. The life of the investment will be 7 years.

What is the NPV?

What is the IRR? Decimal form please.
This project is profitable

True

False
Is the project financially feasible?

Calculation of Cost of Capital

 Risk free return on capital 5.50% Risk Premium 2.25% Cost of Equity 7.75%
 Component % Cost Tax WACC (% x Cost x (1-Tax)) Equity 20% 7.75% 0% 1.55% Debt 80% 4.65% 21% 2.94% 4.49%

Calculation of Principal and Interest payment of Loan

80% of the robot cost will be financed by credit company which is 703,750 x 80% = 563,000

EMI per year = P x r(1+r)n / (1+r)n -1 = 563,000 x 4.65%(1+4.65%)8 / (1+4.65%)8 - 1 = 85,880

EMI Table

 Year Interest Principal Outstanding 1 26,180 59,701 503,299 2 23,403 62,477 440,823 3 20,498 65,382 375,441 4 17,458 68,422 307,019 5 14,276 71,604 235,415 6 10,947 74,933 160,482 7 7,462 78,418 82,064 8 3,816 82,064

Interest is calculated on the outstanding principal. Principal is EMI - Interest.

 Year Particulars 0 1 2 3 4 5 6 7 8 Cost of Robots -703,750 - - - - - - - - Increase in milk prodcution (4900 x 15) - 73,500 74,970 76,469 77,999 79,559 81,150 82,773 - Labour Cost Saved (1,820 x 15) - 27,300 27,846 28,403 28,971 29,550 30,141 30,744 - Repair Costs - -10,000 -10,200 -10,404 -10,612 -10,824 -11,041 -11,262 - Depreciation (703,750/7) - -100,536 -100,536 -100,536 -100,536 -100,536 -100,536 -100,536 - Terminal Value of Robot - - - - - - - 253,387 - Interest - -26,180 -23,403 -20,498 -17,458 -14,276 -10,947 -7,462 -3,816 Profit before tax - -35,915 -31,323 -26,566 -21,636 -16,527 -11,232 247,644 -3,816 Tax @ 21% - 7,542 6,578 5,579 4,544 3,471 2,359 -52,005 801 Profit after tax (PAT) - -28,373 -24,745 -20,987 -17,092 -13,057 -8,873 195,639 -3,015 Operating Cash Flow (PAT - Depn) - 72,163 75,790 79,549 83,443 87,479 91,662 296,174 -3,015 Loan Repayment - -59,701 -62,477 -65,382 -68,422 -71,604 -74,933 -78,418 -82,064 Project Cash Flow -703,750 12,462 13,314 14,167 15,021 15,875 16,729 217,757 -85,079 PVF @ 4.49% 1.0000 0.9570 0.9159 0.8765 0.8389 0.8028 0.7683 0.7353 0.7037 Discounted Cash Flow -703,750 11,927 12,194 12,418 12,601 12,745 12,854 160,121 -59,872 NPV -528,762

IRR is the discount rate at which NPV becomes zero. As per below it becomes zero at negative 19.19%

 Year Particulars 0 1 2 3 4 5 6 7 8 Cost of Robots -703,750 - - - - - - - - Increase in milk prodcution (4900 x 15) - 73,500 74,970 76,469 77,999 79,559 81,150 82,773 - Labour Cost Saved (1,820 x 15) - 27,300 27,846 28,403 28,971 29,550 30,141 30,744 - Repair Costs - -10,000 -10,200 -10,404 -10,612 -10,824 -11,041 -11,262 - Depreciation (703,750/7) - -100,536 -100,536 -100,536 -100,536 -100,536 -100,536 -100,536 - Terminal Value of Robot - - - - - - - 253,387 - Interest - -26,180 -23,403 -20,498 -17,458 -14,276 -10,947 -7,462 -3,816 Profit before tax - -35,915 -31,323 -26,566 -21,636 -16,527 -11,232 247,644 -3,816 Tax @ 21% - 7,542 6,578 5,579 4,544 3,471 2,359 -52,005 801 Profit after tax (PAT) - -28,373 -24,745 -20,987 -17,092 -13,057 -8,873 195,639 -3,015 Operating Cash Flow (PAT - Depn) - 72,163 75,790 79,549 83,443 87,479 91,662 296,174 -3,015 Loan Repayment - -59,701 -62,477 -65,382 -68,422 -71,604 -74,933 -78,418 -82,064 Project Cash Flow -703,750 12,462 13,314 14,167 15,021 15,875 16,729 217,757 -85,079 PVF @ -19.19%% 1.0000 1.2375 1.5313 1.8949 2.3449 2.9017 3.5907 4.4433 5.4984 Discounted Cash Flow -703,750 15,421 20,387 26,845 35,223 46,065 60,069 967,561 -467,797 NPV 25

The project is not profitable as the NPV is negative and also the IRR.

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