Reference no: EM131878425
The Greater Ohio Agriculture and Tree Company (GOAT) has been involved in mowing yards and fields, as well as tree trimming, for the past 50 years. The company is deciding whether to add a herd (several herds actually) of goats to be used to clear areas that require a less manicured look and for individuals who prefer this method of lawn care. As an employee of the company, you have been asked to analyze the goat project.
The Project: Using goats to clear land uses no herbicides, is eco-friendly, and is often 50 percent cheaper than hiring men and machinery. GOAT is trying to determine whether to invest in goat herds. Because it is believed that it will take several years to grow sales, it is estimated that the company will employ 600, 900, 1,100, 1,400, and 1,600 goats per year over the next five years, respectively. The annual cost is expected to be $800 per goat, including veterinary expenses and upkeep. The sales per goat will be $1,500, $1,525, $1,575, $1,600, and $1,650 per year over the next five years, respectively.
The company will also be required to hire goat herders. The annual cost per herder will be $60,000, including all benefits. The management of GOAT has determined that the equipment necessary to transport the goats from job to job, as well as the buildings to house the goats will cost $2.65 million and will be depreciated on a 7-year MACRS schedule. The project will require an investment of 8 percent of current year's total sales in net working capital for each year and will have fixed costs of $275,000 per year.
An outside consultant, who was hired at a cost of $75,000, has determined that the company will lose sales of $110,000, $140,000, $155,000, $195,000, and $240,000 from its existing landscape contracts per year over the next five years, respectively. The existing contracts have a variable cost equal to 45 percent of sales and fixed costs of $325,000 per year.
Other Issues: GOAT believes that the cash flows from the goat mowing operations will grow at an annual rate of 2.2 percent for the indefinite future after Year 5. GOAT has a capital structure of 25 percent debt. The floatation costs of debt are 3 percent and the floatation costs of equity are 6 percent. The company finances the 80 percent of the equity of a project using retained earnings. Because the company feels that the goat project is riskier than its current operations, it will require a risk adjustment factor of 2.5 percent. Net working capital does not require floatation costs. While the goats are on a project, any manure will be left at the project site. However, as goat manure can be used as an effective fertilizer, you feel that each goat will produce $20 worth of manure each year while it is housed at the company's barns.
A close friend who also works for GOAT is aware that you are analyzing the goat mowing project. He recently proposed a gecko project to company management, who rejected the project. The geckos were to be used as an ecologically friendly way to control insects. Your friend comes to you and tells you that the project should not have been rejected as it cost $1.4 million and has cash flows of $320,000 per year for 10 years. In discussing the gecko project with your friend, he notes that it would be easy to add the cost and cash flows from the gecko project to the cash flows of the new goat project and present the one large project to company management.
The tax rate for GOAT is 40 percent. The company has a WACC of 9 percent and has other profitable operations.
Analysis: Calculate the profitability index, NPV and IRR.
Please use Excel and Excel formulas so I can follow and understand.