You own 2200 acres of plantation timberland. After a harvest, a fertilizer repre

Question

You own 2200 acres of plantation timberland. After a harvest, a fertilizer representative approaches you and presents two treatment options to you. The representative recommends doing both treatments, one at year five and one at year eight. You expect to yield 80 tons of pulpwood after 22 years without fertilizer and the pulp prices are expected to be $20/ton at the time of harvest. Combined treatments would result in a 34% increase in your yield at year 22 and he offers you a discounted price of $108/acre but only if you pay this year. He also admits that the treatments can be done by themselves. The earlier treatment (year 5) would cost $40/acre and result in a 12% gain. The later treatment, alone, would result in a 16% gain and cost $90/acre. Both of these treatments would be paid for in the year they are applied and the listing prices would not change. If the S&P 500 typically returns 8%, which treatment option would you chose?

Explanation / Answer

Evaluating the proposal :

Only 1st treatment (12%inc)

Only 2nd Treatment (16%inc)

b.Total Revenue($)

(ax2200acresx$20)

c.PV factor

(PVIAF@8%, 22years)

d.PV of Revenue($)

(b x c)

=$108x2200

=$237,600

=$40x2200

=$88,000

=$90x2200

=$198,000

PVIAF@8%,5years

=0.680

PVIAF@8%, 8years

=0.540

g. PV of cost

(e x f)

h. PV of Profit

(d - g)

Choose only treatmen 1, as the profit is maximum.

Particulars Proposal-1 Proposal-2 Proposal-3 Without any treatment Both Treatment (34%inc)

Only 1st treatment (12%inc)

Only 2nd Treatment (16%inc)

a.Expected Yield per acre 80 tons 107.2 89.6 92.8

b.Total Revenue($)

(ax2200acresx$20)

3,520,000 4,716,800 3,942,400 4,083,200

c.PV factor

(PVIAF@8%, 22years)

0.184 0.184 0.184 0.184

d.PV of Revenue($)

(b x c)

647,680 867,891.2 725,401.6 751,308.8 e.Cost for treatment -

=$108x2200

=$237,600

=$40x2200

=$88,000

=$90x2200

=$198,000

f. PV factor - -

PVIAF@8%,5years

=0.680

PVIAF@8%, 8years

=0.540

g. PV of cost

(e x f)

- $237,600 $59,840 $106,920

h. PV of Profit

(d - g)

$647,680 $630,29102 $665,561.6 $644,388.8

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