Question 5 (33 points) It is the last day of the year for a farmer to decide whether he will invest on a new cow milking platform for his organic free-range farm. The cost of the facility School of Slavonic and East European Studies MAIN EXAMINATION 2018/19 Page 6 of 6 SESS0040 is 9,000 with a life span of three years and can be ready for use on New Year’s Eve. A neighbouring farmer has agreed to buy it at the end of the three years for 2,000. The platform can yield 1,000 litres per year. Power, the only operational cost for the machine, is at 1 per litre and price increases (for both power and milk) are at 3% annually. The wage cost of the specialised worker who will be operating the platform and general expenses for the project, if it goes through, are constant at 20,000 and 17,500 respectively. The farmer faces a tax rate of 35%, a risk-free rate of 70%, a return on equity of 15% and a debt ratio of 40%. All figures are nominal, all costs and expenses are tax deductible, all cash flows occur at the end of the year and you can think the farmer as having set up an agriculture firm which has other profitable activities (the platform is thus part of the firm).
(i) What is the firm’s weighted average cost of capital?
(ii) What is the NPV of the project calculated using the weighted average cost of capital?