The following investment decision is being considered by Citrus Farms. For $7000 the company can acquire ownership of 10 acres of 15-year-old orange trees and a 15-year lease on the land. The productive life of an orange tree is divided into stages as follows:
a) What is the present value of each alternative? Since the land and anything on it will belong to the lessor in 15 years, assume that once the trees are harvested the land will not be replanted by Citrus.
b) As an alternative to this investment, Citrus can use the $7,000 to buy a new orange-sorting machine. The machine would reduce sorting expenses by $1300 a year for 15 years. Which investment would you make? Why? Assume that all other investment opportunities for the next 15 years will earn the cost of capital.
c) In the tenth year Citrus discovers that everyone else with 25-year-old trees has sold them. As a consequence the price the firm can get for the trees is only $8000. Since so many trees have been sold for decoration, small orange crops are expected for the next 5 years. As a result the price of oranges will be higher. Your acreage will yield $1200 a year. The selling price of your trees in another 5 years is expected to be still depressed to $6000. What should you do?
d) Given the situation in (c), what was the NPV of your actual investment over the 15-year period?
e) What would the NPV be if the trees had been sold in year 10 for $8000?