Question

The asking price of an acre of ranch land is currently $675 per acre. The current net cash flow from ranching and farming is $45 per acre, the investor's cost of capital is 8% and the planning horizon is ten years. The inflation rate of current returns is 1% and land values are negative 1%.

A. Evaluate the profitability (NPV) of the investment assuming no taxes and no debt financing.

B. Evaluate the profitability (NPV) of the investment assuming a tax rate of 20%.

C. Evaluate the profitability (NPV) of the investment assuming a tax rate of 20% and debt financing. Assume a 30% down payment, 8% interest rate, equal payments, and 20 year amortization loan.

1. Using the data from problem B. Find the maximum bid price the investor can afford to pay in order to earn an 8% rate of return. Also, find the maximum price for the conditions of problem C.

Answer 1

Part (A)

Please see the table below. Please be guided by the second column titled “Linkage” to understand the mathematics. The last row highlighted in yellow is your answer. Figures in parenthesis, if any, mean negative values. All financials are in $. Adjacent cells in blue contain the formula in excel I have used to get the final output.

Part (B)

Part (C)

Loan amount = PV = (1 - downpayment) x 675 = (1 - 30%) x 675 = 472.50; Rate = 8%; Nper = 20; FV= 0

Annual payment = PMT (Rate, Nper, PV, FV) = PMT (8%, 20, -472.5, 0) = 48.13

Loan balance after 10 years = - PV (Rate, Nper, PMT, FV) = - PV (8%, 10, 48.13, 0) = 322.92

Interest portion from the annual payment can be pulled out using IPMT function

Using the data from problem B. Find the maximum bid price the investor can afford to pay in order to earn an 8% rate of return.

Look at the PV value in part (B) =  542.40

Hence, the maximum bid price the investor can afford to pay in order to earn an 8% rate of return = $ 542.40

Also, find the maximum price for the conditions of problem C.

Look at the PV value in part (C) =  115.36 = 30% x Cost

Hence, max price that can be afforded = 115.36 / 30% = $  384.55