Instructions If money is worth 2½% per quarter, compounded quarterly, which opti

ID: 2597547 • Letter: I

Question

Instructions If money is worth 2½% per quarter, compounded quarterly, which option would you recommend that Brent exercise? P6-6 (L05) (Purchase Price of a Business) During the past year, Stacy McGill planted a new vineyard on 150 acres of land operation. that she leases for $30,000 a year. She has asked you, as her accountant, to assist her in determining the value of her vineya The vineyard will bear no grapes for the first 5 years (1-5), In the next 5 years (6-10), Stacy estimates that the vines will bear grapes that can be sold for $60,000 each year. For the next 20 years (11-30), she expects the harvest will provide annual revenues of $10.000. But during the last 10 years (31-40) of the vineyard's life, she estimates that revenues will decline to $9,000; during the $80,000 per year During the first 5 years, the annual cost of pruning, fertilizing, and caring for the vineyard is estimated at years of production, 6-40, these costs will rise to $12,000 per year. T Assume that all receipts and payments are made at the end of each year he relevant market rate of interest for the entire period is 6%.

Explanation / Answer

Firstly, we need to find out the present value of cash outflows:

Lease rent per year = 30000

Life of land = 40 years

Market rate of interest = 6%

Present value of lease rent for 40 years = 30000*Present value annuity factor(6%,40)

= 30000*15.046 = 451380

Annual cost for first 5 years = 9000

Present value of annual cost for first 5 years = 9000*Present value annuity factor (6%, 5)

= 9000*4.2123 = 37910.70

Annual cost from 6th year to 40th year = 12000

Present value of annual cost for second 35 years = 12000*[Present value annuity factor (6%, 40) - Present value annuity factor (6%, 5)]

= 12000*[15.046 - 4.2123] = 12000*10.8337 = 130004.4

Total Present value of cash outflows = 451380+37910.70+130004.4 = 619295.1 i.e. 619295( approx)

Calculation of Present value of cash inflows

Year

Annual revenues

Present value annuity factor

Present Value

1-5

6-10

60000

Present value annuity factor(6%,10) – Present value annuity factor(6%,5)= 7.36 – 4.2123 = 3.1477

60000*3.1477 = 188862

11-30

110000

Present value annuity factor(6%,30) – Present value annuity factor(6%,10)= 13.764 – 7.36 = 6.404

110000*6.404 = 704440

31-40

80000

Present value annuity factor(6%,40) – Present value annuity factor(6%,30)= 15.046 – 13.764 = 1.282

80000*1.282 = 102560

TOTAL

995862

Value of Vineyard operation:

= Present value of total cash inflows - Present value of total cash outflows

= 995862 – 619295 = 376567