AGRICULTURAL ECONOMICS 330



AGRICULTURAL ECONOMICS 330

Assignment 4

Instructor: Dr. David J. Leatham

Name: Seat Number: Section:

(If your answer does not match the answers given below, check with the instructor. There is always the chance, albeit small, that your answer is correct and there is a typo below.)

1. A farmer is thinking about investing in a center pivot irrigation system to irrigate 120 acres of land in Dawson County. This land is used to produce cotton and is currently a dryland operation. Current production is approximately ¾ bale of cotton per acre. The current operating expenses are $100 per acre. With an irrigation system, operating expenses would increase by $125 per acre due to electricity, maintenance and additional labor (Total operating expense = $225). The irrigation system will be used during periods of low precipitation for the growing of cotton and for preparing the ground for breaking. It is estimated that the irrigation will increase yields and thus operating receipts by $200 per acre. The cost for drilling a well would be $9,180 (Table 1) and the cost for the center pivot irrigation system would be $33,000. The irrigation system would be ¼ mile long and would irrigate 120 acres. This system would run off electricity and would be able to apply any amount of water over any given period. Suppose that the farmer wants to evaluate this investment over a five-year period of time. The farmer believes that if he sold the farm in five years, the irrigation system would add $30,000 to the sale price. The farmer anticipates that his marginal tax rate over the next six years will be 15%. The IRS will allow the farmer to depreciate the investment ($33,000 + $9,180) using straight-line over 15 years. Assume that the terminal value of this investment is $30,000 at the end of five years. The farmer requires a 12% return to capital (pretax).

|Table 1.. Cost of Drilling Well |

|Item |Cost |

|Drilling ($12/ft) |$1,800 |

|Casing ($60/hr) |180 |

|Cement |200 |

|Test Pump |1,100 |

|Fuel for Test Pump |500 |

|Complete Installation |4,000 |

|Underground Pipe |1,400 |

|Total Cost |$9180 |

1.1 Lay out the cash flows for the investment.

1.2 Calculate the net present value (NPV=$6,548) and the internal rate of return (yield).

1.3 Discuss whether the irrigation system is a profitable investment.

2. Your firm is considering a fast-food concession at the World's Fair in College Station. The cash flow pattern is somewhat unusual because you must build the stands, operate them for 2 years, and then tear the stands down at the end of the third year to restore the sites to their original condition (the stand sits idle for one year). Your firm requires a 15% pre-tax return on capital. Your firm anticipates having a marginal tax rate of 20% for the next three years. The IRS will allow your firm to depreciate the initial cost of the investment over two years. The cost of tearing down the booth is considered a tax deductible expense. You estimate that it will cost $900,000 to build and $200,000 to tear down at the end of the third year (assume the terminal value and after-tax terminal value are zero and treat the tear-down cost as an expense at the end of the third year). Your revenues will be $850,000 and operating expenses will be $200,000 at the end of each of the first two years from operating the concession stand.

A. Lay out the cash flows for the investment.

B. Calculate the net present value (NPV=$17,046).

C. Is this an acceptable investment?

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