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.