You are interested in purchasing a tract of agricultural land. The seller proposed a price to you of $3,200/acre. The seller is currently renting out the land for $175/acre which you believe to be a reasonable estimate of the return on land that you could receive in your first year of ownership. You expect that both annual earnings and the land’s market value will grow at 2.5 % annually. You currently face an after-tax opportunity cost of capital of 6.5%, a marginal income tax rate of 28%; and a fixed capital gains tax of 15%.
i. Calculate the NPV for a 10, 20, and 30 year planning horizons.
ii. Assuming no taxes, and 0 % growth rate for both cash flows and land value, calculate the approximate Bid Price of land.
iii. Calculate the correct bid prices of land for the 10, 20 and 30 years planning horizons.
iv. Given your answers above, should you purchase the land at its current price? Should you attempt to re-negotiate the terms of the sale? Explain briefly.