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
Group of answer choices

True

False
Is the project financially feasible?

Homework Answers

Answer #1

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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