The deduction from gross income and total variable costs to arrive at Operating Profit, Net Profit then Growth in Equity over a production period of one year for the Maambos farm business are displayed in the following figure.

a. Calculate Operating Profit, Net Profit and Growth in Equity over one year for the Maambo Familys Farm business.

Note that apart from income on crops, the Maambo family also earned interest of K 204,480 on their bank balance at the beginning of the year.

b. Calculate Annual Net Cash Flow and amount of Cash for the Balance Sheet at the end of the year.

Note: The Cash Flow Budget does not contain an amount for depreciation because it is an allowance, not a cash cost. Further, it does include an item for reduction of loan at the beginning of the year because it is an amount paid from Net Profit.

c. Construct a Balance Sheet for the Maambo family at the end of the year.

Note: The difference between Equity in the Balance Sheet at the start of the year and the Equity in the Balance Sheet at the end of the year must be the same as the Increase in Equity calculated for Operating Profit, Net Profit and Growth in Equity over the year of production.

There are three main things that business people who manage farms wish to know. First, has the equity in their business grown over the year. What has been the efficiency of their farming operation? That is determined by dividing the Operating Profit by the average value of their total farm assets over the year. Third, has there been an increase in their holding of cash at the end of the year?

Calculate those parameters and comment on their relative value.

Also calculate the gearing ratio (liabilities divided by the equity in the balance sheet at the end of the year). Comment on its value in terms of the measurement of risk for the Maambo Familys farm business.

d. Discounted Cash Flow

You will understand that to obtain a sum of money now instead of in the future is important. This is because when you get money in the present time you could invest it at a particular interest rate. The amount of money would grow into the future.

Say that you were promised an amount of money and that it was worth K 10,000 now. You are given the option of receiving it in 5 years into the future. You know that you could invest it now a current rate of interest of 10 per cent per annum. If you waited for 5 years the amount that you would receive would be less at K 6,209.21.

The same process is involved in investment analysis. To get an idea of what a future stream of cash was worth as a lump sum today you would have to calculate its Net Present Value. This can be achieved by applying the following equation.

Where:

= Sum of

C_t = Net cash inflow for the period t

Co = the initial investment

r = the discount rate

t = the number periods (years)

Note that NPVs are an assessment of wealth.

It is a common experience for commercial farmers to increase their wealth by renting land rather than by purchasing it. The reason is that they obtain economies of scale. That is, the extra land will attract a rental fee, but the overhead or fixed costs will be held to a minimum.

The Maambo Family have been offered the rental of 200 hectares of land that borders their farm. The amount of annual rent will be K 6,250 for 10 years.

The Maambo Family want an earning rate on capital invested of 20 % per annum. That is, the discount rate will be 20% per annum.

They will have to invest on day one an extra K 900,000 for machinery. The salvage value at the end of year 10 has been estimated at K 350,000. That amount is not discounted. b. That is, depreciation is not a fixed expense.

Five years of the rotation repeated for a further five years are shown below. Also displayed are yields per hectare for the various crops with estimated prices per tonne and extra variable costs.

All items are in nominal values that include inflation. Extra income is per annum is multiplied by a productivity increase of 15% per annum. Inflation is also 15% per annum per annum charged on total extra cost per annum to get extra costs after inflation.

Calculate NPV and IRR for the investment analysis and comment on the Maambo Familys decision to carry out the investment.

See attachment for the layout as an Excel spreadsheet.

Note: The value of the extra NPV is equal to the sum of the annual discounted value of extra net benefits after inflation plus the salvage value of machinery.

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Total Income Variable Costs Total Gross Margin Fixed Cost Interest Taxation Operating Profit Net Profit Growth in Equity 204,480 X Calculation of Net Profit and Increase in Equity Annual Income Income from Soybeans Income from Maize Income from Sunflower Income from Cassava Interest eamed Total Income (Revenue) Annual Expenses Variable costs Soy beans Maize Sunflower Cassava Total variable costs X Fixed costs Owner-operators allowance 1,750,000 Administration expenses 1,000,000 Depreciation 10% of depreciable assets Total Fixed costs X Total Expenses Operating Profit Less interest paid on loan 13% of loan in Balance sheet 325,000 Less interest paid on overdraft 12,000 Total interest Net Profit Less Tax paid 30% of Net Profit Increase in Equity X X 337,000 X x Calculation of Annual Net Cash Flow K K Cash in Total crop income Interest received Total income Expenses Total crop variable expenses Owner operator allowance Administration Loan reduction Interest paid on loan Interest paid on cash on hand Tax paid Total costs Annual Net Cash Flow Add cash in Balance Sheet at start of year Cash in Balance Sheet at End of Year Net Present Value T Ct NPV = - .Co t-1 (1+r)t Item Year 2 3 4 5 Crop Soybeans Maize Sunflower Maize Cassava Area Yield/ha Hectares tomes 200 3.0 200 5.0 200 2.5 200 5.0 200 10.5 Price/ tonne K 4.200 2,500 4.700 2,500 1.200 Extra Variable Costs/ha K 5,980 4.250 4.280 4.250 5,280 Item Year 1 2 3 4 5 Crop Soyabeans Maize Sunflower Maize Cassava 200 200 200 200 200 kg/ha K K 15% 15% 15% 15% 15% Area Yield Price per tonne Extra income Increase in productivity Extra income Extra machinery Extra variable costs/ha Lease/ha Extra costs per ha K -900,000 K K K K K 15% 15% 15% 15% 15% K K 30% 30% 30% 30% 30% Total extra cost Inflation Extra costs after inflatior Extra net benefits Tax on extra benefits Tax on extra benefits Extra benefits after tax Discount rate Discounted value Add Salvage value K K 20% 20% 20% 20% 20% K K 350,000 NPV IRR % Total Income Variable Costs Total Gross Margin Fixed Cost Interest Taxation Operating Profit Net Profit Growth in Equity 204,480 X Calculation of Net Profit and Increase in Equity Annual Income Income from Soybeans Income from Maize Income from Sunflower Income from Cassava Interest eamed Total Income (Revenue) Annual Expenses Variable costs Soy beans Maize Sunflower Cassava Total variable costs X Fixed costs Owner-operators allowance 1,750,000 Administration expenses 1,000,000 Depreciation 10% of depreciable assets Total Fixed costs X Total Expenses Operating Profit Less interest paid on loan 13% of loan in Balance sheet 325,000 Less interest paid on overdraft 12,000 Total interest Net Profit Less Tax paid 30% of Net Profit Increase in Equity X X 337,000 X x Calculation of Annual Net Cash Flow K K Cash in Total crop income Interest received Total income Expenses Total crop variable expenses Owner operator allowance Administration Loan reduction Interest paid on loan Interest paid on cash on hand Tax paid Total costs Annual Net Cash Flow Add cash in Balance Sheet at start of year Cash in Balance Sheet at End of Year Net Present Value T Ct NPV = - .Co t-1 (1+r)t Item Year 2 3 4 5 Crop Soybeans Maize Sunflower Maize Cassava Area Yield/ha Hectares tomes 200 3.0 200 5.0 200 2.5 200 5.0 200 10.5 Price/ tonne K 4.200 2,500 4.700 2,500 1.200 Extra Variable Costs/ha K 5,980 4.250 4.280 4.250 5,280 Item Year 1 2 3 4 5 Crop Soyabeans Maize Sunflower Maize Cassava 200 200 200 200 200 kg/ha K K 15% 15% 15% 15% 15% Area Yield Price per tonne Extra income Increase in productivity Extra income Extra machinery Extra variable costs/ha Lease/ha Extra costs per ha K -900,000 K K K K K 15% 15% 15% 15% 15% K K 30% 30% 30% 30% 30% Total extra cost Inflation Extra costs after inflatior Extra net benefits Tax on extra benefits Tax on extra benefits Extra benefits after tax Discount rate Discounted value Add Salvage value K K 20% 20% 20% 20% 20% K K 350,000 NPV IRR %