Question

Suppose you are a corn farmer in your home state. You have to decide between two projects. One project is to purchase new equipment for your farm that will help boost your profits for the next 10 years. You also find out that you can purchase a large banana farm in Brazil for the same price as the equipment, and at the current market price for bananas you will make a lot more profit than you would from purchasing new corn farming equipment.

After asking around, you find out that the standard discount rate for evaluating the NPV of the farming project is 6%. Most farmers in your home state seem to use this rate successfully. However, you don’t know any other banana farmers and you don’t know too much about farming in Brazil, so you have to make a guess on an appropriate discount rate for the Brazilian banana farm. Based on the concepts from the background readings, would you say the Brazilian banana farm will need a lower or higher discount rate? A lot larger or smaller, or only

Answer 1

I think Brazilian banana farm will need a higher discount rate because it is not appropriate to use the discount rate of the industry which is used as a standard discount rate.

I would advocate for adjustment of the discount rate with appropriate risk weighted factors which will decide the overall rate of return of this project.

This discount rate needs to be readjusted on the basis of various factors like inflation, interest rate risk and other geo political risk as well because this discount rate cannot be used for a period of next 10 years. This has been used in the past so this will have to be readjusted with the futuristic risk weighted measures in order to ascertain an appropriate discount rate while accepting and rejecting of this project.

I will rather discount this project with the higher rate in order to stay conservative and in order to make this project more risk-proof so it can only be accepted after passing through higher discounting rate factor.