Agricultural Financial Managemnet

AGEC 2404
Spring 1994

Problem Set V
Time Value of Money and Repayment Analysis/Financial Plans

Part I: Time Value (45 points) ______

Part II: Repayment Analysis/Finance Plans (55 points)

______

Total ______

Letter Grade
______
Part I: Time Value (45 points)

1. (10 points)
A. It is 1994 and you have a 2-year old daughter who will be going to
college in 16 years. In the year 2010, Virginia Tech will have a
tuition plan that allows for a one-time lump sum payment at the
time of admission which will cover your daughter's costs
regardless of how long it takes her to graduate. Current
investments are running 6% annually. If the projected lump sum
cost of tuition is $250,000, how much money will you have to
invest annually in order to have $250,00 on hand in 16 years?

Investments of $9,738 per year must be made.

$250,000 / 25.673 Future Value of Annuity = $9,738

per year

B. Fast forward to the year 2010. You have been a spendthrift and
have saved only $100,000 for your daughter's tuition plan. Your
above average income precludes her from qualifying for financial
aid, so you go to see your friendly banker for one of their academic
loans. If you borrow the deficit at a 12% annual interest rate for
20 years, what are your annual payments going to be if the banker
lets you pay once a year. How much would you save if you made
12 monthly payments instead?

I would need to borrow $150,000 ($250,000 - $100,000).

If I am going to make an annual payment on this loan in
will cost me $20,085 per year, But if I make monthly
payments it would only cost me $19,818 per year ($165.50
per month), and would save me $267 a year.

Paying Annually = $150,000 x 0.1339 Annuity Factor

= $20,085.00
Paying Monthly = $150 x 11.01 Monthly Annuity
Factor = $165.50
$165.50 x 12 Months = $19,818
2. (15 points)
A. You have just graduated from college and have been approached
by your financial planner. The planner encourages you to begin
saving for your retirement immediately at the age of 25. If you
plan on retiring at the age of 65 and IRAs are paying 5%
compounded annually, how much will you accumulate if you
deposit a maximum of $2,000 annually.

I would acculumate $241,600 by age 65.

$2,000 x 120.800 Future Value Annuity Factor =

$241,600

B. After considering your financial planner's advice, you remember

that you are a member of Generation X (even if you don't like to
be stereotyped as such and hate that term). You want to enjoy
life now (and later). You make an informed decision to enjoy the
next decade and start saving at age 35. If you want a nest egg
the same size as in Part A, how much will you have to deposit
annually in a tax-deferred savings plan in addition to your $2,000 a
year IRA deposits assuming the same retirement age and rate of
return?

I would have to put away $1,636 annually above the

$2,000 I put in my IRA to give me a $241,600 nest egg.

$241,600 / 3636.5 Future Value Annuity Factor =

$3,636
$3,636 - $2,000 IRA deposit = $1,636 of additional
annual savings needed

C. Using the information from Part A, what would be the value of the
IRA ar retirement age if the annual interest rate was 10%?

My IRA would be worth $885,186 at age 65.

$2,000 x 442.593 Future Value Annuity Factor =

$885,186

D. Using the interest rate in Part C (10%), assume you are in and will
say in the 28% Federal Tax Bracket. What is the marginal benefit
of investing in the tax-deductible IRA compared to paying the tax
 on the $2,000?

There is a $247,852 benefit in investing in the IRA.

$2,000 x 28% = $560 annual tax

$560 x 442.593 Future Value Annuity Factor =
$247,852
3. (30 points)
A. You plan on purchasing a new townhouse on the future golf course
that is being built just outside of town. The project is still in the
planning stage and construction of the homes will not begin for
another 5 years. You talk to you friendly banker and find out their
policy on mortagage loans on townhouses in new subdivisions
requires a 20% downpayment. If the purchase price of the house
is projected to be $110,000 in 5 years and investments are paying
8% annually, how much will you need to save each year to have
enough for the down payment?

I will have to be saving $3,750 a year at 8% annually to

have the necessary $22,000 required for a down payment
in 5 years.

$110,000 x 20% = $22,000

$22,000 / 5.867 Future Value Annuity Factor = $3,750

B. It is time to buy your house on the golf course and your banker
agrees to allow you to make an annual mortgage payment each
year after you get your income tax refund. If the mortgage
carries a 7.5% fixed annual interest rate for 30 years, what is your
annual payment?

I will have to pay $7,454 per year for my mortgage at 7.5%

fixed annual interest.

$88,000 x .0806 Future Value Annuity Factor (7%) =

$7,093
$88,000 x .0888 Future Value Annuity Factor (8%) =
$7,814
$7,814 - $7,093 = $721
$721 / 2 = $361
$361 + $7,093 = $7,454 ($7,814 - $361 = $7,454)

C. How much will your house be worth in 10 years if it appreciates in

value 10% each year?

The house should be worth $285,307.

$110,000 x 2.5937 Future Value Annuity Factor =

$285
,307
 D. What would the house be worth if it appreciates 4% compounded
semi-annually for 10 years? What non-financial factors might
influence its value?

The house should be worth $163,449. There are many

non-financial factors that could influence the value of the
house. Among these are environmental hazards nearby or
under the land the house itself was built upon, nearby and
regional development, the style of the townhouse,
drainage and perculation ability of the land, quality of
craftsmanship, improvements made to the house or the
land, and inflation.

4% / 2 = 2%
10 Years x 2 = 20 years
$110,000 x 1.4859 Future Value Annuity Factor
(adjusted to 2% for 20 years) = $163,449

E. You win the $10 million Reader's Digest Sweepstakes. They will
send you $1 million annually for 10 years. If investments are
paying 5% compounded annually, what is the present value of
your prize?

My big $10 million dollar prize would be worth $7,21,700

before the state and federal tax people got their cut.
Assuming a 35% federal and 10% state tax, my prize would
only be worth $3,474,765.

$1,000,000 x 7.7217 Future Value Annuity Factor =

$7,721,700
$1,000,000 x 45% state and federal tax = $450,000
$450,000 x 7.7217 Future Value Annuity Factor =
$3,474,765
Part II: Repayment Analysis/Finance Plans (55 points)

Quarterly Projected Earnings Summary

1st Qtr 2nd Qtr 3rd Qtr 4th Qtr Total

Income $135,000 $206,500 $280,000 $90,000

$711,500

Expenses $195,500 $119,750 $147,000 $118,000

$580,250

Family Living $12,000 $14,500 $22,200 $19,000

$67,700

Debt Payments $0 $0 $41,673 $2,590

$44,263

Residual ($72,500) $72,250 $69,127 ($45,590)

$19,287

Cumulative Residual $0 $0 $0 $68,877

$0

Operating Loan $72,500 ($72,250) ($250) $0 $0

Net $0 $0 $68,877 $19,287

$19,287

Owed on
Operating Loan $72,500 $250 $0 $0
 Key Ratios

Gross Receipts from Farm Operations

Income $711,500
(-) Off-Farm Inc $35,000
(=) $676,500

Net Farm Income From Operations

Gross Reciepts $676,500
(-) Expenses $580,250
(-) Interest $24,260
(-) Depreciation $40,000
(=) $31,990

Coverage Ratio
Net Farm Income $31,990
(+) Off-Farm Inc $35,000
(+) Interest $24,260
(+) Deprciation $40,000
(-) Family Living $67,700
(=) $63,550
(/) Payments $44,263
(=) 1.44 ($19,287 Margin)

Debt:Asset Ratio
Debts $434,260
(/) Assets $758,000
(=) 57%

Return on Assets
Net Farm Income $31,990
(+) Interest $24,260
(-) Operator Fee $43,825 (assumes 1 Operator x $10,000 + 5% Gross
Revenue)
(=) $12,425
(/) Total Assets $758,000
(=) 1.6%

Weighted Cost of Capital

(57% Debt x 8%) 4.56
(43% Assets x 6%) 2.58
(=) 7.14

Current Ratio
Current Assets $298,000
(/) Cur Liabilities $62,263
(=) 4.79
 Sensitivity Analysis

Revenue Drop
Margin $19,287
(/) Gross Revenue $676,500
(=) 2.9%

Expense Rise
Margin $19,287
(/) Expenses $580,250
(=) 3.3%

Interest Rise
Margin $19,287
(/) Liabilities $434,260
(=) 4.4%
-- Note Tonya has no Variable Interest Loans