Reference no: EM132824532
Question - Kraus Farming is a small family run dairy farm, owned by Jurgen Kraus, who has a commitment to sustainable farming. After visiting a farm in Vermont, USA, Kraus Farming are considering buying equipment that will enable them to produce electricity on the farm, by converting manure and organic matter into biogas. There is a $15,000 local government grant available for such projects (so if they go ahead $15,000 of the cost will be paid by the government, effectively reducing the cost to Kraus Farming). Costs to date and equipment needed are given below, along with the benefits:
i. The cost of the fact-finding trip to Vermont, USA, made by Jurgen Kraus earlier in the year was $12,000.
ii. The farm will need to install a digester and generator building (with a tank to collect the cow manure and keep it for 3 weeks at 38 degrees Celsius to produce methane gas) - cost to install $850,000. (Estimated life 20 years).
iii. Purchase and installation of modified natural gas engine to convert methane to electricity $50,000. (Estimated life 20 years).
iv. The electricity generated will replace 80% of Kraus Farming's own needs. Currently they pay 40 cents per kWh (kilowatt hour) and use 60,000 kWh per year.
v. In addition, they will sell enough power for 300 homes to the local electricity grid which will total 995,000 kWh per year at 25 cents per kWh.
vi. The business' required rate of return (cost of capital) is 10%.
vii. Kraus Farming has previously preferred all capital expenditure items to pay for themselves (payback) within three (3) years.
Required -
a) Calculate the total relevant cost of the project.
b) Calculate the total cash inflows/savings of the project.
c) Assume all costs (for all equipment) are incurred at the start of the project and annual cash flows occur at the end of each year. Calculate the Net Present Value of the project.
d) Calculate the Payback Period of the project.
e) Based on these calculations alone, should Kraus Farming buy the machine? Use your calculations to justify your answer.
f) Are there any non-economic considerations in making this decision?