Agricultural Economics 330



Agricultural Economics 330

Examination 2

Instructor: Dr. David J. Leatham

Name: Seat Number: Section:

NOTE: SHOW A TIME LINE AND THE PRESENT VALUE OR FUTURE VALUE FORMULAS USED TO SOLVE EACH PROBLEM INVOLVING TIME. NO POINTS WILL BE GIVEN WITHOUT A TIME LINE AND FORMULAS EVEN IF YOU HAVE THE RIGHT ANSWER!

EXAM POINTS ARE IN PARENTHESIS.

(16) 1. True or False (Circle the correct answer)

|True or False | |

| |Question: |

|True or False |The yield on an investment is always equal to the discount rate used to calculate the NPV. |

|True or False |The depreciable life of an investment (allowable by the IRS) may be different from the life of an investment. |

|True or False |A pre-tax discount rate is converted to an after-tax discount rate by multiplying the pre-tax discount rate by (1-the |

| |inflation rate). |

|True or False |The tax basis of an asset is calculated by subtracting the accumulated depreciation from the projected terminal value. |

|True or False |If the nominal price of an apple is $1 five years from today and the inflation rate is positive, then the price of an |

| |apple today is also $1. |

|True or False |Inflation will not affect the annual depreciation a farmer can claim as a tax deduction after a tractor is purchased. |

|True or False |An investment can have a positive net present value but not be financially feasible. |

|True or False |Nominal cashflows are discounted with a nominal discount rate. |

(10) 2. List four important characteristics of farmland and seven special factors affecting the value of land.

3. Mr. Agirich is tired of suffering heavy losses from deer damage to his 100-acre orchard. He has read in the Farm Bureau News that a New York apple producer buried a copper stranded wire around his orchard. The wire does not carry electricity, just a harmless radio signal. His dogs were outfitted with special collars containing battery-operated receivers, which give an electronic signal when the dog gets within a certain distance from the fence. The dogs are allowed to roam free in the orchard, thus discouraging deer from feasting on fruit buds and damaging new plantings. Mr. Agirich believes that deer damage costs him $3,500 per year and this would be saved if dogs were allowed to roam in the orchard. The fence should have a 10-year life and is virtually maintenance free. The only regular expense is replacement of dog collars. The cost is about $35 per dog per year. Mr. Agirich believes four dogs would be sufficient and because the dogs would be pets, he will not assign a cost to the dogs. The fence would be worthless after 10 years. Assume it would cost Mr. Agirich $20,000 to put in the fence, Mr. Agirich has other investment opportunities that promise to return 10%, the IRS will allow the fence to be depreciated using straight-line over three years, and the marginal tax rate is 30% (Ignore risk and inflation).

(10) A. Calculate the present value of the after-tax net returns from this investment if Mr. Agirich plans to keep the fence for 10 years.

[PV(After Tax NR) = 16,519.46]

(10) B. Calculate the present value of tax savings from depreciating the fence if Mr. Agirich plans to keep the fence for 10 years.

[PV(Tax Savings: Depreciation) = 5,248.63]

(5) C. Calculate the net present value of this investment if Mr. Agirich plans to keep the fence for 10 years. Is this an acceptable investment? [NPV= 1,768.10]

D. Suppose that Mr. Agirich can borrow $18,000 from the bank and the loan will be fully amortized over 15 years at 18% (annual payments):

(12) 1. Calculate the Net Cash Flows after Debt for the first, second, third and fourth year. Does Mr. Agirich have a potential liquidity problem in the third and fourth year. Explain.

[1st =1788.75, 2nd =1772.81, 3rd=1753.99, 4th=-268.21]

(5) 2. Suppose the lender requires that Mr. Agirich pay the remaining principal balance of the loan (balloon payment) at the end of the 10th year. Calculate the balloon payment by calculating the book value of the loan. [Book value=11,055.33]

(12) E. Originally Mr. Agirich decided not to assign a cost for keeping the dogs. How much could Mr. Agirich pay for the dogs each year and still have this be a profitable/acceptable investment? Assume that the IRS will not allow the dogs to be depreciated for tax purposes. Treat this as an annual expense that is tax deductible.

[X= 359.62]

4. Suppose Mr. Agirich of Aggie Farms is considering the purchase of additional farmland. He can purchase an acre of land for $600. Assume that Mr. Agirich can borrow $500 per acre from the bank and the loan will be fully amortized over 20 years at 8% (annual payments). Also, assume that the inflation rate will be 3%, the marginal tax rate is 40%, the average tax rate is 12%, and the Mr. Agirich requires at least a 10% pre-tax, risk-free return on capital and a 5% risk premium on projects of comparable risk.

(15) A. Suppose Mr. Agirich sells the land in 10 years. Calculate the present value of the after-tax terminal value if the real purchase price of land of $600 per acre is assumed to increase by 7% each year. [503.4]

(5) B. Calculate the real after-tax, risk-adjusted discount rate.[5.825%]

................
................

In order to avoid copyright disputes, this page is only a partial summary.

Google Online Preview   Download