Question

Discounting. According to economic theory, agricultural land values (prices) equal the present value of expected future rents, where rents are calculated as the difference between revenue received and production costs. Suppose the interest rate is 5% and expected future rents on 1 acre of land are as follows: A. Year 1:$125 B. Year2: $250 C. Year3: $3201. What is the price of land?

Answer 1

$622.233

Step-by-step explanation:

The computation of the price of land is shown below:

The discount factor should be computed by

= 1 ÷ (1 + rate) ^ years

where,

rate is 5%

Year = 0,1,2,3

Discount Factor:

For Year 1 = 1 ÷ 1.05^1 = 0.9524

For Year 2 = 1 ÷ 1.05^2 = 0.9070

For Year 3 = 1 ÷ 1.05^3 = 0.8638

So, the calculation of a Present value of all yearly cash inflows are shown below

= Year 1 cash inflow × Present Factor of Year 1 + Year 2 cash inflow × Present Factor of Year 2 + Year 3 cash inflow × Present Factor of Year 3

= $125 × 0.9524 + $250 × 0.9070+ $320 × 0.8638

= $119.047 + $226.7574 + $276.428

= $622.233