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.
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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Calculate the maximum pre-tax loan interest rate that they can be charged and still justify investing in the project.
Transcribed Image Text: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.
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