Agdist Corporation distributes agricultural equipment. The board of directors is
ID: 1113013 • Letter: A
Question
Agdist Corporation distributes agricultural equipment. The board of directors is considering a proposal to establish a facility to manufacture an electronically controlled "intelligent" crop sprayer invented by a professor at a local university. This crop sprayer project would require an investment of $8 million in assets and would produce an annual after-tax net benefit of $2.4 million over a service life of six years. All costs and benefits are included in these figures. When the projectterminates, the net proceeds from the sale of the assets will be $1 million. Compute the rate of return of this project. Is this a good project at MARR=14%?
Explanation / Answer
Solution :- For the computation of rate of return in the given question, take two trial discount rates. One discount rate is where present value of cash inflows are greater than the present value of cash outflow and the another discount rate is where the present value of cash inflows are lesser than the present value of cash outflow.
At 20 % Discount rate,
Present value of cash inflows = 2.4 Million * [ 1 - (1.20)-6 ] / 0.20 + 1Million / (1.20)6
= 2.4 Million * [ 1 - 0.3355 ] / 0.20 + 1 Million / 2.98
= 2. 4Million * 0.6645 / 0.20 + 0.3355 Million
= 7.974 Million + 0.3355 Million
= $ 8.3095 Million.
At 23 % Discount rate,
Present value of cash inflows = 2.4 Million * [ 1 - (1.23)-6 ] / 0.23 + 1 Million / (1.23)6
= 2.4 Million * [ 1 - 0.2890 ] / 0.23 + 1Million / 3.46
= 2.4 Million * 0.711 / 0.23 + 0.2890 Million
= 7.419 Million + 0.2890 Million
= $ 7.708 Million.
Accordingly, The rate of return lies between 20 % and 23 %. By inter-polation, it is calculated as follows :-
= 20 % + (23 % - 20 %) * (8.3095Million - 8 Million) / (8.3095 Million - 7.708 Million)
= 20 % + 3 % * 0.3095 Million / 0.6015 Million
= 20 % + 3 % * 0.514
= 20 % + 1.54%
= 21.54 % (approx).
Conclusion :- Rate of return on the project in the above given question = 21.54 % (approx).
The project is good at MARR of 14 % because the rate of return (21.54 %) is greater than the MARR of 14 %.