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TAMU AGEC 330 - ch10-11

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Study Guide Chapter1 10-11Question 1Question 2Question 3Question 4Slide 6Question 5Question 6Question 7Question 7 AnswerQuestion 8Question 8 AnswerQuestion 9Question 9 Part AQuestion 9 Part BQuestion 9 Part CSlide 17Slide 18Question 10Answer 10Question 11Question 12Slide 23Slide 24Slide 25Question 13Slide 27Question 14Slide 29Slide 30Slide 31Slide 32Slide 33Question 15Slide 35Slide 36Slide 37Slide 38Slide 39Slide 40Answer 15.DQuestion 16Slide 43Slide 44Slide 45Slide 46Answer 16Question 17Answer 17Question 18Slide 51Question 19Slide 53Question 19 ConintuedInterestQuestion 20Slide 57Question 20 ContinuedSlide 59Slide 60Slide 61Question 21Slide 63Slide 64Slide 65Slide 66Question 21 ContinuedSlide 68Problem 21 ContinuedSlide 70Question 22Question 23Question 24Question 25Question 25 AnswerQuestion 26Slide 77Slide 78Question 27Slide 80Slide 81Investment DescriptionSlide 83Slide 84Question 2.ADiscount Rate: After-tax risk-adjusted rateCalculate NPVQuestion 2.BBreak-EvenSlide 90Question 2.CSensitivity AnalysisSlide 93Question 2.DSlide 95Present Value of After-Tax Net ReturnsQuestion 3.ASlide 98Question 3.BSlide 100Question 3.CFinancial FeasibilityQuestion 3.DPotential Liquidity ProblemQuestion 3.EFinancially FeasibleSlide 107Slide 108Slide 109Slide 110Investment Description (cont.)Slide 112Slide 113Slide 114Slide 115Slide 116Slide 117Slide 118Slide 119Slide 120Slide 121Slide 122Slide 123Slide 124Slide 125Slide 126Slide 127Slide 128Slide 129Slide 130Slide 131Slide 132Slide 133Slide 134Slide 135Slide 136Slide 137Slide 138Slide 139Study GuideChapter1 10-11Agricultural Economics 330Instructor: David J. LeathamQuestion 1Suppose you have an opportunity to purchase an investment for $600 and the investment promises to return $1,000 in five years. Does the yield on this investment increase or decrease if you can buy this investment for $580 instead of $600. Circle one.IncreaseQuestion 2Suppose you have $10,000 in your savings account and you are investigating the possibility of investing in bonds. If you believe that interest rates are going to go up over the next three years, should you invest in bonds. Justify your answer.Probably not. If interest rate go up, the value of the bonds you purchase will go down. If you wait to buy the bonds at higher interest rates, the price will be lower. If you buy them now, you are locked into the lower interest rate and a decreasing value of the bond.Question 3What does a Net Present Value equal to 0, imply about a project’s rate of return.The rate of return on the investment (internal rate of return --IRR) is equal to the required rate of return on the investment (discount rate).Question 4Suppose that you have eight annual payments of $3,425 left to pay on a loan with the first payment due in one year. You can borrow money at 9% and the bank is willing to sell back the note for $18,000. Should you buy back this loan? Assume that you would need to borrow the $18,000 if you buy back the loan.Market Value = 3,425 [USPV9%, 8] = 18,9570 8MV r = 9 %1 2...3,4253,4253,425The market value of this contract is $18,957. You can buy it for $18,000. Buy it back.Question 5Suppose the real price of a tractor in 10 years is $55,000. What is the nominal price of the tractor if inflation is 3%?F10 = 55,000(1+.03)10 = 73,915.4 Fn = F*n (1+If)nQuestion 6Suppose you are considering an investment that will increase operating receipts by $10,000 and operating expenses by $6,000. Calculate the after-tax net returns if your marginal tax rate is 15% and your required rate of return on investments is 20%. After-tax net returns = (10,000-6,000)(1-.15)=4,000(.85) = 3,400Question 7Suppose you are considering an investment that costs $35,000. You plan on selling the investment in five years for $10,000. The IRS will allow you to depreciate this investment over four years. Calculate the tax savings from depreciation in the fourth and fifth year if you use the straight-line method of calculating depreciation and your marginal tax rate is 15%.Question 7AnswerAnnual Depreciation for tax purposes = (35,000/4) = 8,750Tax savings from depreciation = 8,750*.15 = 1,312.5Tax savings in the fourth year is $1,312.5Tax savings in the fifth year is 0 because the investment is depreciated completely (for tax purposes) over the first four years.Question 8Suppose you are considering an investment that costs $60,000. You plan on selling the investment in ten years for $20,000. Calculate the present value of the after-tax terminal value if accumulated depreciation is $30,000, your marginal tax rate is 15%, and your required rate of return on investments is 10%.Question 8AnswerAfter-tax Terminal Value = 20,000-[20,000-(60,000-30,000)].15= 21,500After-tax discount rate = .1(1-.15) = 0.085 or 8.5%0 10V0 21,500r = 8.5 %V0 = 21,500 (1+.085)-10 = 9,509.14Question 9Suppose that you are considering the purchase of a bond that matures in 12 years. The bond has a par value of $1,000, it pays a coupon of 10 percent (annually), and the coupon is paid semiannually (10s). Coupon payment every six months = (.10*1,000)/2 = $50Question 9Part ACalculate the market value (price) of the bond today if the bond’s market rate (yield) is 7%.0 24MV r = 7/2 %= 3.5 %1 2...505050Market Value = price = 50[USPV3.5%,24] + 1,000 (1+.035)-24=$1,240.881,000Question 9Part BCalculate the market value (price) of the bond in five years if the bond’s market rate is 4%.0 10MV r =4/2 %= 2 %1 2...505050Market Value = price = 50[USPV2%,10] + 1,000 (1+.02)-10=$1,269.481,000Question 9Part CCalculate the Net Present Value and the Internal Rate of Return on this bond investment if the current market rate on this bond is 7%, you expect the market rate to be 4% in 5 years, you plan to sell the bond in five years, and your required rate of return on this investment is 8% (4% semiannually). Is this an acceptable investment? (hint: use the purchase price in part A, and the sell price in part B)0 10- 1,240.88 r =8/2 %= 4 %1 2...5050501,363.19NPV = -1,240.88 + 50[USPV4%,10] + 1,363.19 (1+.04)-10= -1,240.88 + 1,326.47 = 85.590 10- 1,240.88 r =?/2 %= ? %1 2...5050501,363.19NPV = 0 = -1,240.88 + 50[USPVr%,10] + 1,363.19 (1+.r)-10r = IRR = 4.82% (semiannual rate)r = IRR = 2*4.82 = 9.63%This is an acceptable investment. NPV > 0 and the IRR > 8%.Question 10.


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