StudyGuide.pptVIP

Study GuideChapter1 12-13 Agricultural Economics 330 Instructor: David J. Leatham Question 1 Question 2 When choosing a discount rate, what is the lower bound (the lowest acceptable discount rate)? The discount rate must be at least as high as the cost of capital. Thus the cost of capital forms a lower bound. If the discount rate was set any lower, investments would be taken that would not recover the cost of capital. Question 3 The lowest marginal tax rate for most farm and ranch firms is at least 30.3%. Explain why. There are two primary taxes: Federal Income Tax and Self-employment tax. The lowest marginal tax rate for federal income taxes is 15% and the lowest marginal tax for self-employment taxes is 15.3%. Combined, the marginal tax rate is 30.3% Question 4 Give an example of a mutually exclusive investment. A farmer has decided on putting in an irrigation system. The farmer can use hand set, wheel line, flood, or center pivot irrigation. The choice of the irrigation system is mutually exclusive because the farmer can only choose one system out of the four alternatives. Question 5 Calculate the present value of the after-tax net returns to land in the 7th year if the real pre-tax net returns to land today are $100, real net returns to land are assumed to increase by 4% each year, the inflation rate is 5%, the marginal tax rate is 30%, and the pretax risk adjusted discount rate is 10%. Show all your work. Investment Description Investment Description Question 6 Calculate the average tax rate for Aggieland Farms if the meadow land is not purchased. Answer Average tax rate = (4,400/55,000) 8% Question 7 What is the marginal tax rate for Aggieland Farms. Answer 30% Question 8 Calculate the Net Present Value for the meadow land investment. Discount Rate:After-tax risk-adjusted rate r = [ rbt + PREM ] (1-m) r = after-tax, risk-adjusted discount rate rbt = before-tax, risk-free discount rate PREM = risk premium -- adjustment for risk m = marginal tax rate