Question

A farmer has been given the opportunity to become a part owner in a local fertilizer business. If the farmer becomes an owner of the fertilizer business, he will receive $4,000 each year from the firm's profits. In addition, the farmer will receive a discount on fertilizer and he believes the discount will reduce his fertilizer costs by $2,000 per year. The farmer plans to retire in 25 years and thinks he can sell his equity in the fertilizer business for $50,000.

(i) Calculate the market value of this investment if the market rate of return on comparable investments is 8%

a. $28,650

b. $71,350

c. $103,815

d. $68,514

e. None of the above

(ii)           Calculate the Net Present Value if the price of this investment is $60,000 and the farmer’s required rate of return is 15% (discount rate) and state if this investment is acceptable.

a.            -$31,350; Unacceptable

b.            $43,815; Acceptable

c.             $11,350; Acceptable

d.            $8,514; Acceptable

e. None of the above

(iii)          Calculate the yield on this investment if the price of this investment is $60,000 and state if this investment is acceptable if the required rate of return is 15%.

a.            9.8%; Acceptable

b.            22.9%; Acceptable

c.             3.53%; Unacceptable

d.            15%; Acceptable

e. None of the above

(iv)         After the farmer has purchased part of the fertilizer business, he discovered that the decrease in fertilizer costs per year was only $1,000 per year instead of the $2,000 he was expecting and he only sold the business for $5,000. Given that he paid $60,000 for the business, what was the true yield?

a.            8.9%

b.            8.1%

c.             15.0%

d.            6.85%

e. None of the above

Answer 1

i) Market Value is $71350. Calculation given below:

ii) Option e is correct. (None of them).

iii) Yield on this investment= 9.8%.Calculation is given below:

Year	Cash Flow
0	-60000
1	6000
2	6000
3	6000
4	6000
5	6000
6	6000
7	6000
8	6000
9	6000
10	6000
11	6000
12	6000
13	6000
14	6000
15	6000
16	6000
17	6000
18	6000
19	6000
20	6000
21	6000
22	6000
23	6000
24	6000
25	56000
IRR	9.83%

As this less than 15% which is ROR, so project is not acceptable. Option e is correct.

iv)

Now True Yield is 6.85%. Calculation given below:

Year	Cash Flow
0	-60000
1	5000
2	5000
3	5000
4	5000
5	5000
6	5000
7	5000
8	5000
9	5000
10	5000
11	5000
12	5000
13	5000
14	5000
15	5000
16	5000
17	5000
18	5000
19	5000
20	5000
21	5000
22	5000
23	5000
24	5000
25	10000
IRR	6.85%