You are thinking of expanding your cattle herd and are looking for additional pasture- land. The asking price of an acre of pasture is currently $600 per acre. Based on your assumptions about how many head of cattle you will put on this land, you estimate the current net cash flow from ranching is $40 per acre, your nominal cost of capital is 8% and the planning horizon is 20 years. You expect current returns to grow at 1% per year and land values to grow at 2% per year.
(a) Evaluate the profitability (Net Present Value) of this farmland investment assuming no taxes and no debt financing (i.e. you will pay for the entire purchase up front).
(b) Evaluate the NPV of the investment assuming a tax rate of 20% on income and 15% on capital gains.
(c) Find the maximum bid price you can afford to pay in order to earn an 8% rate of return, assuming you must pay taxes on income and capital gains as above.