AGB 555
Activity 7
Due: Next Class Period
Dr. Hurley
80 Points
Today’s activity will have you focus on using the internal rate of return as a method for
examining investments. You will also examine the intricacies of the incremental rate of return as
a decision tool. Please calculate all your answers in a spreadsheet.
Problem 1: Suppose you have just retired at the age of 30 having made multi-millions of dollars
in Silicon Valley having created the hottest new phone app. Since you were raised on a small
hobby farm in the Sacramento Valley, you have decided that you would like to return to the
valley to get into farming. You have set aside $7 million to invest in two possible orchard
investments. One investment revolves around purchasing 500 acres of almond ground for
$7,000 per acre. The second investment entails purchasing 500 acres of ground suitable for
plums at a price of $7,635 per acre.
If you decide to buy the almond acreage it is going to cost you $4,573 per acre to get the crop
producing a steady return. Once you are receiving returns, you can expect that each acre in that
first year will cost you $2,768 in operating costs, and will return $4,070. You should expect
after year 1 that your operating costs and returns will increase by 6% per year. You expect the
lifespan of the trees to be 22 years.
If you purchase the plum acreage, it will cost you $6,077 per acre to get the crop producing a
stable return. Once you are receiving returns you can expect the costs will be $3,611 per acre in
year 1. In that first year, you can expect to receive $5,600 per acre in returns. After year 1, you
should expect that your cost and returns will increase by 2% each year. Plum trees should be
productive for 22 years.
Question A: Based on a minimum attractive rate of return of 12%, what is the present worth of
each decision? Which crop would you choose?
Question B: Calculate the internal rate of return for each orchard and explain which orchard you
would choose based on this criterion.
Question C: Calculate the incremental rate of return. Based on whether you are examining
increments of investments or increments of borrowing, what orchard should you choose to invest
in? Please explain your answer.
Question D: Graph the present worth of incremental returns in terms of interest rates. Start the
interest rate at 0% and increment up by 0.5% up to 100%. It could be helpful to use Excel’s Data
Table tool. Explain what you see in the graph.
Question E: Calculate the modified internal rate of return using both Excel and formulas for
your investment given an investment rate of 12% per year and a borrowing rate of 6% per year.
Problem 2: Do questions 7-13, 7-77, and 7A-23 (make sure you follow directions on page 266
for this last question).