Description

CAPITAL INVESTMENT ANALYSIS

Donald W. Lybecker and Karen L. Holman
Department of Agricultural & Natural Resource Economics
Colorado State University, Fort Collins, CO 80523, July 1987
Modified for Windows Spreadsheets by Duane Griffith
Extension Farm Management Specialist
Montana State University, December 1995

See Macros Page Tab for Available Macros

This template analyzes the profitability of a capital investment

using Net Present Value (NPV) and Internal Rate of Return (IRR). Since
not all profitable investments are financially feasible, the template
also evaluates the financial feasibility of the investment from a cash
flow standpoint. The template evaluates assets with a useful life of up
to 20 years. It uses MACRS depreciation and loan amortization with
single annual payments.

Profitability:

A profitable investment will have a positive NPV. IRR indicates

the rate of return earned by this investment. Profitability is calculated
as total receipts less expenses less income tax, discounted to the
present using the weighted cost of capital. Simply stated, it means
that over time receipts exceed expenses in today's dollars.

Financial Feasibility:

The second part of the analysis shows in which years this investment
generates a negative cash flow. The net return calculated above
is adjusted for principal and interest payments, less any tax savings
due to interest. Before undertaking the investment, the operator should
reasonably certain he can make up any negative cash flows from other
sources.

Net present value is calculated using the weighted cost of capital;

that is, a weighted average of the after-tax loan rate on borrowed capital
and the opportunity cost on equity capital.

Cash income and cash expenses are both multiplied by the expected
inflation rate for each year. Income tax is computed as total receipts
- total expenses - depreciation * the marginal tax rate.

Depreciation is computed by the appropriate MACRS method. Due to

distortions inherent in the declining balance method, the last year of
depreciation may be higher than the previous year.

It is assumed that the asset is sold for "salvage value" at the

end of the asset's life. Since book value is presumably 0, the asset
sale is treated as income and the proceeds taxed.

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Any loan on the investment is amortized by equal annual payments.

Tax savings from interest payments are computed as interest paid * tax
rate and deducted from the total payment to give an after-tax payment.
This is deducted from net receipts to compute net cash flow.

The template is designed to analyze an asset with a useful life of

2 to 20 years. The recovery period is associated only with asset depreciation
for tax purposes, and may well be different from the asset life.
However, the more closely the recovery period (tax depreciation) and
useful life (management depreciation) match, the more accurate the
analysis.

Some investments may show a "negative" income tax. The template

assumes that this tax savings can be used within the business to reduce
the overall tax liability. This assumption may not apply to all farms.

Input Item Input Definitions

Name (tractor, combine, etc.): Descriptive name for item being analyzed
Purchase Price: Total price paid, cash + loan
Salvage Value: Estimated sale value at end of analysis period
Recovery Period (3,5,7,15,20 yrs): Tax life (MACRS) of asset
Asset Life (2-20 yrs): Expected useful life of asset; or length of analysis
Expensing ($10,000 maximum): Dollars of investment claimed as current expense
Income Tax Rate: Marginal income tax rate (rate on last dollar earned)
Percent Financed by Loan: Portion of purchase price that is borrowed
Loan Interest Rate: Annual interest rate charged on this loan
Loan Length (years): Term of loan in years
Opportunity Cost: Rate equity capital could earn if invested elsewhere
Cash Income: Gross income expected from investment in first year
Cash Expenses: Cash costs incurred by investment in first year
Inflation Rate: Expected inflation rate for income & expenses

Note: Enter percents as decimals (e.g., .28, not 28).

TEMPLATE OPERATIONS

Operation of this template under Windows, is significantly different than

operation under the old DOS version. The program has been divided into
pages with each page representing a portion of the input or results. The screen
will show page tabs that contain the 1) Instructions, 2) Input, 3) NPV Results,
and 4) the profitability and financial feasibility results. The input page also
contains several intermediate calculations displayed or used in the results in
other locations.
To move around and input data or view results, click on the page tab at the
bottom or top of the screen (depends on what windows spreadsheet you are
using).

ERROR MESSAGES

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Input Errors:

The template checks for certain error conditions during data entry.
Such error conditions include assets with a life other than 3, 5, 7, 15
or 20 years; salvage value > purchase price; loan > purchase price; etc.

Read any error messages or comments displayed by the template.

Select INPUT and change your data if necessary. You may choose to ignore
the message if the data is correct for your particular analysis.

TEMPLATE LAYOUT

DOCUMENTATION Description Page Tab (Rows 1 through 128)

INPUTS Program Page Tab (Cell block C14 through C27)
RESULTS Program Page Tab (Cell block J1 through AE34)
Profitability Results (Cell block J1 through AE17)
Financial Feasibility Results (Cell block J19 through AE34)
COMMENTS/ERRORS Program Page Tab (Cell block AH9 through AK17)
LOAN AMORTIZATION Program Page Tab (Cell block AH22 through AK49)
DEPRECIATION Program Page Tab (Cell block AQ1 through BM12)

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rough AE34)

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CAPITAL INVESTMENT ANALYSIS

Calculations, Profitability and Financial Feasiblity Analysis>>>
Donald W. Lybecker and Karen L. Holman
Department of Agricultural & Natural Resource Economics
Colorado State University, Fort Collins, CO 80523, July 1987

Modified for Windows Spreadsheets by Duane Griffith

Extension Farm Management Specialist
Montana State University, December 1995

The double lined box below is the ONLY input required for this program.
Inputs for Analysis: Comments/Error Messages

Name (tractor, combine, etc.): Chopper

Purchase Price: $24,000
Salvage Value: $2,000 0
Recovery Period (3,5,7,15,20 yrs): 7 0
Asset Life (2-20 yrs): 10 0
Expensing ($10,000 maximum): $0 0
Income Tax Rate: 28.00% 0
Percent Financed by Loan: 75.00% 0
Loan Interest Rate: 9.00% 0
Loan Length (years): 5 0
Opportunity Cost: 6.00% 0
Cash Income: $0 0
Cash Expenses: $1,240 0
Inflation Rate: 5.00% 0

Results and Interpretation for NPV and IRR.

Net Present Value (NPV)----------------------------> ($25,578.09)

Internal Rate of Return (IRR)----------------------> Err:523

If NPV is positive, the investment is profitable if you are analyzing an

investment that generates an identifable cash inflow. If you are analyzing
and investment that has only cash outflows associated with it, (Fuel, oil,
repairs, taxes, etc.) then the NPV will always be negative.
In this case, alternative investments are choosen by selecting the smallest
negative number.

IRR is the rate actually being earned on the investment

under these input assumptions. Please note however, that the IRR is
not a "reliable" measure. It often produces inaccurate results and may display
Err or #NUM!.

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Profitability: Chopper

Year Year Year Year

0 1 2 3

Receipts 0 0 0 0
Salvage Value 0 0 0 0
Total Receipts: 0 0 0 0

Expenses 24,000 1,240 1,302 1,367

Income Tax 0 -2,267 -1,736 -1,362
Total Expenses: 24,000 -1,027 -434 5

Net Receipts: -24,000 1,027 434 -5

NPV: ($25,578)
IRR: Err:523

Financial Feasibility: Chopper

Year Year Year Year

0 1 2 3

Net receipts: -6,000 1,027 434 -5

Principal: 0 3,008 3,278 3,573

Interest: 0 1,620 1,349 1,054
Total payment: 0 4,628 4,628 4,628
Tax savings on
interest: 0 454 378 295
After-tax pmt: 0 4,174 4,250 4,332

Net cash flow: -6,000 -3,147 -3,816 -4,337

Profitability:

A profitable investment will have a positive NPV. IRR indicates

the rate of return earned by this investment. Profitability is calcu-
lated as total receipts less expenses less income tax, discounted to the
present using the weighted cost of capital. Simply stated, it means
that over time receipts exceed expenses in today's dollars.

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Year Year Year Year Year Year Year Year

4 5 6 7 8 9 10 11

0 0 0 0 0 0 0 0
0 0 0 0 0 0 2,000 0
0 0 0 0 0 0 2,000 0

1,435 1,507 1,583 1,662 1,745 1,832 1,924 0

-1,102 -922 -800 -1,358 -489 -513 21 0
334 585 782 304 1,256 1,319 1,945 0

-334 -585 -782 -304 -1,256 -1,319 55 0

Year Year Year Year Year Year Year Year

4 5 6 7 8 9 10 11

-334 -585 -782 -304 -1,256 -1,319 55 0

3,895 4,246 0 0 0 0 0 0
733 382 0 0 0 0 0 0
4,628 4,628 0 0 0 0 0 0

205 107 0 0 0 0 0 0
4,423 4,521 0 0 0 0 0 0

-4,756 -5,106 -782 -304 -1,256 -1,319 55 0

Financial Feasibility:

The second part of the analysis shows in which

ment generates a negative cash flow. The net retu
is adjusted for principal and interest payments, les
due to interest. Before undertaking the investment
reasonably certain he can make up any negative ca
sources.

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Year Year Year Year Year Year Year Year

12 13 14 15 16 17 18 19

0 0 0 0 0 0 0 0
0 0 0 0 0 0 0 0
0 0 0 0 0 0 0 0

0 0 0 0 0 0 0 0
0 0 0 0 0 0 0 0
0 0 0 0 0 0 0 0

0 0 0 0 0 0 0 0

Year Year Year Year Year Year Year Year

12 13 14 15 16 17 18 19

0 0 0 0 0 0 0 0

0 0 0 0 0 0 0 0
0 0 0 0 0 0 0 0
0 0 0 0 0 0 0 0

0 0 0 0 0 0 0 0
0 0 0 0 0 0 0 0

0 0 0 0 0 0 0 0

part of the analysis shows in which years this invest-

a negative cash flow. The net return calculated above
principal and interest payments, less any tax savings
Before undertaking the investment, the operator should
ain he can make up any negative cash flows from other

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WEIGHTED COST OF CALCULATION

Year WEIGHTED COST OF CAPITAL:

20

0
0
0
COMMENTS AND ERROR MESSAGES
0 -
0 SV > Purchase Price
0 Not a Recovery Period
Life not in Range
0 Exceeds Expensing Max
Tax Rate > 40%
Loan > Purchase Price
Asset Life < RecoveryPd

Year
20 LOAN AMORTIZATION CALCULATION

0 Year
0
0 1
2
0 3
0 4
5
0 6
7
8
9
10
11
12
13
14
15
16
17
18
19
20

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TED COST OF CALCULATION Depreciation

GHTED COST OF CAPITAL: 6.36%

Recovery Year
Period 1
3 0
5 0
7 6,857
ENTS AND ERROR MESSAGES 15 0
- - 20 0
Interest > 30%
ecovery Period Loan Length > 20 yrs Total 6,857
Opportunity Cost > 30%
s Expensing Max Income > Purchase Price
Exp. > Purchase Price
Purchase Price Inflation Rate > 30%
ife < RecoveryPd Loan life > Asset Life

AMORTIZATION CALCULATIONS:

Payment: 4,628

Rem. Balance Interest Principal

18,000 1,620 3,008

14,992 1,349 3,278
11,714 1,054 3,573
8,141 733 3,895
4,246 382 4,246
0 0 0
0 0 0
0 0 0
0 0 0
0 0 0
0 0 0
0 0 0
0 0 0
0 0 0
0 0 0
0 0 0
0 0 0
0 0 0
0 0 0
0 0 0

Total Principal Repaid--------> 18,000

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Year Year Year Year Year Year Year Year Year

2 3 4 5 6 7 8 9 10
0 0
0 0 0 0
4,898 3,499 2,499 1,785 1,275 3,187
0 0 0 0 0 0 0 0 0
0 0 0 0 0 0 0 0 0

4,898 3,499 2,499 1,785 1,275 3,187 0 0 0

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Year Year Year Year Year Year Year Year Year

11 12 13 14 15 16 17 18 19

0 0 0 0 0
0 0 0 0 0 0 0 0 0

0 0 0 0 0 0 0 0 0

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Year
20 Sum
0
0
24,000
0
0 0

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NAME RANGE PURPOSE

-------- ----------- --------------------------------------------------
BASIS D5 Depreciable basis for this asset
FEASIB K21 Cell to GOTO for feasibility details on screen
INPUTRANGE B1..F20 Range for /Range Input command
LIFE D8 Asset life
LOAN D13 Loan length
PROFIT K1 Cell to GOTO for profitability details on screen

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