Mr. Agirich of Aggie Farms is considering the purchase of 100 acres of prime ranch land that is adjacent the ranch he now owns. Mr. Agirich can operate the additional 100 acres with present labor, machinery and breeding livestock. The land is selling for $400 per acre. Mr. Agirich believes that the operating receipts per acre of land per year will $450 and operating expenses will be $420 in present dollars. Mr. Agirich expects that the inflation rate will be 3% and operating receipts and expenses per acre will increase at the rate of inflation. The farmer will sell the land in three years and he anticipates that land prices will increase at the rate of inflation (from a base price of $400). A bank will loan him $350 per acre of land and the loan will be fully amortized over 15 years at 10% (annual payments). The outstanding balance of the loan will be paid at the end of the third year (balloon payment). Assume that the marginal tax rate is 30% and that Mr. Agirich requires at least a 6% pre-tax, risk-free return on capital and a 4% risk premium on projects of comparable risk. (Do the analysis on a per acre basis.)
1. What is the annual real pre-tax Net Returns in the third year?
2. What is the annual nominal pre-tax Net Returns in the third year?
3. What is the annual nominal after-tax Net Returns in the third year?
4. What is the nominal tax savings from depreciation?
5. What is the nominal pre-tax terminal value in four years?
6. What is the after-tax terminal value in four years?
7. What is the accumulated depreciation over the four years?
8. What is the after-tax risk adjusted discount rate?
9. What is the present value of the after-tax net returns?
10. What is the present value of tax savings from depreciation?
11. What is the present value of after-tax terminal value?
12. What is the Net Present Value?
13. What is the annual loan payment?
14. What is the loan balance at the end of the third year?
15. What is the tax savings from interest payments in the third year?
16. What is the Net Cash Flow after debt flows at the end of the second year?
17. Financial Feasibility is not a problem? (True or False)
18. What maximum price should Mr. Agirich be willing to pay for an acre of land?
19. What is the annual real pre-tax Net Returns in the third year?
20. What is the annual nominal pre-tax Net Returns in the third year?
21. What is the annual nominal after-tax Net Returns in the third year?
22. What is the real pre-tax terminal value in three years?
23. What is the nominal pre-tax terminal value in three years?
24. What is the after-tax nominal terminal value in three years?
25. What is the present value of the after-tax net returns?
26. What is the present value of after-tax terminal value?
27. What is the Net Present Value?