Question

Description

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.)

QUESTION 1

1. What is the annual real pre-tax Net Returns in the third year?

   		$30.00
   		$32.78
   		$22.95
   		$0
   		None of the above

10 points   

QUESTION 2

1. What is the annual nominal pre-tax Net Returns in the third year?

   		$30.00
   		$32.78
   		$22.95
   		$0
   		None of the above

10 points   

QUESTION 3

1. What is the annual nominal after-tax Net Returns in the third year?

   		$30.00
   		$32.78
   		$22.95
   		$0
   		None of the above

10 points   

QUESTION 4

1. What is the nominal tax savings from depreciation?

   		$30.00
   		$32.78
   		$22.95
   		$0
   		None of the above

10 points   

QUESTION 5

1. What is the nominal pre-tax terminal value in three years?

   		$400
   		$437
   		$425
   		$500
   		None of the above

10 points   

QUESTION 6

1. What is the after-tax terminal value in three years?

   		$400
   		$437
   		$425
   		$500
   		None of the above

10 points   

QUESTION 7

1. What is the accumulated depreciation over the three years?

   		$400
   		$437
   		$425
   		$500
   		None of the above

10 points   

QUESTION 8

1. What is the after-tax risk adjusted discount rate?

   		7%
   		6%
   		5%
   		3%
   		None of the above

10 points   

QUESTION 9

1. What is the present value of the after-tax net returns?

   		$400
   		$347.71
   		$6.12
   		$58.41
   		None of the above

10 points   

QUESTION 10

1. What is the present value of tax savings from depreciation?

   		$400
   		$347.71
   		$6.12
   		$58.41
   		None of the above

10 points   

QUESTION 11

1. What is the present value of after-tax terminal value?

   		$400
   		$347.71
   		$6.12
   		$58.41
   		None of the above

10 points   

QUESTION 12

1. What is the Net Present Value?

   		$400
   		$347.71
   		$6.12
   		$58.41
   		None of the above

10 points   

QUESTION 13

1. What is the annual loan payment?

   		$313.54
   		$46.02
   		$9.81
   		-$13.57
   		None of the above

10 points   

QUESTION 14

1. What is the loan balance at the end of the third year?

   		$313.54
   		$46.02
   		$9.81
   		-$13.57
   		None of the above

10 points   

QUESTION 15

1. What is the tax savings from interest payments in the third year?

   		$313.54
   		$46.02
   		$9.81
   		-$13.57
   		None of the above

10 points   

Answer 1

Answer 1: Annual real pre-tax Net Returns in the third year is $30.00.

Explanation: Real returns are not affected by the inflation, therefore Annual pre-tax Net Returns in the third year is equal to Operating receipts-Operating expenses, i.e., $450-$420=$30.

Answer 2: Annual Nominal pre-tax Net Returns in the third year is $32.78.

Explanation: Nominal pre-tax net returns= Operating receipts in third year - Operating expenses in third year.

Given that the inflation rate is 3%, operating receipts and operating expenses in the third year will be $491.72 and $458.94. Hence, the Nominal pre-tax net returns is $32.78(491.72-458.94)

Answer 3: Annual Nominal after-tax Net Returns in the third year is $22.95.

Explanation: Tax rate is given as 30%, Tax amount on revenue of $32.78= 30% of $32.78=$9.83. Hence after deducting tax out of revenue $32.78-$9.83, we get Annual nominal after tax net returns=$22.95.

Answer 4: Nominal tax savings from depreciation is $0.

Explanation: Since there is no depreciation on land tax saving from depreciation is 0.