17C) Mr. Agirich has the opportunity to purchase some farm land at $3,000/acre.
ID: 2794851 • Letter: 1
Question
17C)
Mr. Agirich has the opportunity to purchase some farm land at $3,000/acre. He expects that real land prices will increase at 5% per year and inflation will be 2%. His pretax risk adjusted discount rate is 14%. Assume that the land will be sold in 10 years and the marginal tax rate is 23%. The effective interest rate on land loans is 6%.
Calculate the after-tax risk adjusted discount rate.
a. 14% b. 10.7%
c. 6% d. 4.6%
e. None of the answers are correct
Enter Response Here:
(ii) Calculate the real price of land in 10 years.
a. $3,657 b. $8,291
c. $4,887 d. $5,373
e. None of the answers are correct
Enter Response Here:
(iii) Calculate the nominal price of land in 10 years.
a. $4,458 b. $6,550
c. $10,019 d. $5,957
e. None of the answers are correct
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(iv) Calculate the after-tax terminal value of the land.
a. $5,957 b. $5,277
c. $4,887 d. $3,000
e. None of the answers are correct
Enter Response Here:
(v) Calculate the Present Value of the after-tax terminal value.
a. $2,140 b. $1,756
c. $1,896 d. $1,077
e. None of the answers are correct
Enter Response Here:
(vi) What is the approximate maximum bid price for this land?
a. $5,140 b. $4,756
c. $4,077 d. $4,896
e. None of the answers are correct
Explanation / Answer
i) After tax risk adjusted discount rate
After tax risk adjusted discount rate = Pre tax risk adjusted discount rate * (1 - Tax)
= 14% * (1 - 23%)
= 10.78%
Correct answer is option b i.e. 10.7%
ii) Real price of land in 10 years
Future value = Initial investment * ((1 + growth rate) ^ number of years)
= 3000 * ((1 + 5%)^10) = $ 4886.68
Correct answer is option c i.e. $4887
iii) Nominal price of land in 10 years
Nominal rate = [(1 + growth rate) / (1 + inflation rate)] - 1
= [(1 + 5%) / (1 + 2%)] - 1 = 0.0194 *100 = 1.94%
Future value = Initial investment * (1 + nominal rate)^number of yeras
= 3000 * ( 1 + 1.94%) ^ 10
= $ 3635.5
Correct answer is option e i.e. none of the above
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