Fred and Freida have always wanted to enter the pecan business. They locate a 150-acre pecan orchard in Lee County, Georgia. They figure that the annual yield from the trees will be 2200 pounds per acre. Each pound is estimated to sell for $2.25. In order to get started, they must pay $2,450,000 for the land plus $120,000 for equipment. The equipment will be depreciated to a zero estimated salvage value at the end of 20 years. They believe that at the end of 20 years they will sell the land and retire. Annual operating expenses, exclusive of depreciation, are estimated to be $250,000. The land is expected to appreciate in value at a rate of 1.00 percent per year. Assume the marginal tax rate is 28% for ordinary income and capital gains and losses. The project will be funded with 40% debt and 60% equity. The asset beta for the project is 1.25. The risk free rate of interest is 4.5% annually and the market risk premium is 7.8% annually. Assume they can borrow interest at a rate of 8% annually.

Fred and Freida have always wanted to enter the pecan business. They locate a 150-acre pecan orchard in Lee County, Georgia. They figure that the annual yield from the trees will be 2200 pounds per acre. Each pound is estimated to sell for $2.25. In order to get started, they must pay $2,450,000 for the land plus $120,000 for equipment. The equipment will be depreciated to a zero estimated salvage value at the end of 20 years. They believe that at the end of 20 years they will sell the land and retire. Annual operating expenses, exclusive of depreciation, are estimated to be $250,000. The land is expected to appreciate in value at a rate of 1.00 percent per year. Assume the marginal tax rate is 28% for ordinary income and capital gains and losses. The project will be funded with 40% debt and 60% equity. The asset beta for the project is 1.25. The risk free rate of interest is 4.5% annually and the market risk premium is 7.8% annually. Assume they can borrow interest at a rate of 8% annually.

EBK CONTEMPORARY FINANCIAL MANAGEMENT

14th Edition

ISBN:9781337514835

Author:MOYER

Publisher:MOYER

Chapter10: Capital Budgeting: Decision Criteria And Real Option

Section: Chapter Questions

Problem 13P

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