Question

A rancher is considering the purchase of additional land to expand operations. He can operate an additional 1000 acres with present labor and machinery. The land is selling for $750 per acre. This rancher believes that the operating revenue per acre of land will be $550 and operating expenses will be $450 in present dollars. He expects the inflation rate will be 3%. The rancher will sell the land in 3 years and he anticipates that land prices will increase at the rate of inflation from the base of $750 per acre. A bank will loan him $600 per acre of land and the loan will be fully amortized over 15 years at 12% (annual payments). The outstanding balance of the loan will be paid at the end of the third year. Assume that the marginal tax rate is 15% and that he requires at least an 8% pre-tax, risk-free return on capital and a 2% risk premium on projects of comparable risk.

(i) Calculate the nominal after-tax net returns at the end of year 2.

            a. $78.30                                                         b. $84.52

           c. $90.18                                                       d. None of the answers are correct

Enter Response Here:

(ii) What is the present value of the nominal after tax net return after 3 years?

            a. $258.10                                                      b. $213.27

            c. $230.01                                                     d. None of the answers are correct

Enter Response Here:

(iii) What is present value of the after-tax terminal value after 3 years?

            a. $612.38                                                      b. $628.66

            c. $633.46                                                     d. None of the answers are correct

Enter Response Here:

(iv) What is the net present value?

            a. $134.89                                                      b. $97.22

            c. $113.47                                                     d. None of the answers are correct

THE ANSWERS WILL NOT BE "NONE OF THE ANSWERS ARE CORRECT"

Answer 1

I have provided the answers below. Detailed workings are available after the questions.

(i) Calculate the nominal after-tax net returns at the end of year 2.

The correct answer is option  c. $90.18   

(ii) What is the present value of the nominal after tax net return after 3 years?

The correct answer is d. None of the answers are correct

(iii) What is present value of the after-tax terminal value after 3 years?

The correct answer is option c. $633.46

(iv) What is the net present value?

The correct answer is option c. $113.47

Please see the table below. Please be guided by the second column titled “Linkage” to understand the mathematics. The cells highlighted in yellow contain your answer. Figures in parenthesis, if any, mean negative values. All financials are in $. However the answers are to be reported in $ '000, hence you will have to divide each value by 1,000. Adjacent cells in blue contain the formula in excel I have used to get the final output.