Question

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?

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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