PalmCorp is a plantation company that has just invested in a new plot of land this month. PalmCorp only expects cash flows to be generated from this investment in 2 years’ time. The first cash flow is estimated to be $100,000 and is expected to grow by 10% per annum for the following 5 years. The plot of land costs $400,000.
(a) PalmCorp intends to fund this investment by a secondary equity market offering. PalmCorp tracks the agricultural market with a beta of 0.9, and this market presents a risk premium of 5%. You may assume an annual risk free rate of 1.5%. Compute the cost of capital of this plot of land.
(b) What is the internal rate of return of this plot of land?
(c) If PalmCorp actually chooses to purchase the plot of land with a weighted average cost of capital of 4.5%, what is the net present value of this plot of land?