Using NPV, evaluate an investment in a hog farrow-to-finish enterprise. It is a
ID: 2783547 • Letter: U
Question
Using NPV, evaluate an investment in a hog farrow-to-finish enterprise. It is a small, capital-intensive system that utilizes the latest technology in feed distribution, waste disposal, and animal care. The system has a capacity of 280 litters per year with 140 sows farrowing every six months. The litters can be sold for $455 each at a cost of $380. Assume a cash purchase of the buildings, equipment, and livestock using the investor’s equity capital. Given the above and following information, fill out the following table with your calculations.
Initial Investment
$100,000 Buildings
$ 40,000 Equipment $ 10,080 Livestock
The breeding livestock fall in the three-year class for tax depreciation purposes while the buildings and equipment are in the eight-year class. Depreciation is calculated using straight line depreciation methods and assuming no salvage value. The government has offered an incentive to encourage investment in buildings and equipment. Depreciation on buildings and equipment can be accelerated to 12 their typical useful life.
Planning Horizon
The investor uses a 10-year planning horizon.
Terminal Value
The terminal value in year 10 is projected to be $30,000 and is fully taxable.
Required rate-of-return
The investor stipulates a required rate-of-return of 9 percent.
Net Cash Flows
Net cash flows to the investor are determined by deducting projected operating expenses and income tax obligations from projected operating receipts in each year of the planning period.
Remember that depreciation is a NONCASH expense that is used for calculating income taxes only.
The initial investment is a negative cash outflow at present.
The terminal value is considered part of the cash flow in the final period.
In response to inflation, both the operating receipts and expenses are projected to increase at 3 percent per year. For simplicity, an income tax rate of 20 percent is assumed.
Growth Rate in Receipts & Expenses 3-Year property Income Tax Rate 8-year property Number of Litters Terminal Value Gross Income/Litter Direct Cost/Litter Discount RateExplanation / Answer
Here, half life of building depreciation will not help as the initial cash flows are very small. (Half life means depreciation of 35000 per year which is more than the net revenue, which will not result in significant tax saving and on the other side, higher taxes will need to be paid in future and thus not required for enhancing NPV).
Depreciation Volume 280 Investment A B Sales Price 455 Building and equipent 140000 17500 A/8 Cost 380 Livestock 10080 3360 A/3 Revenue per litter 75