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EXTENDED ANALYSIS AND INTERPRETATION PROBLEMS AIP 13.7 Davenport Farms Davenport Farms is a family-owned fruit-growing operation. The farm currently includes 120 hectares of orchards of apples, pears, and cherries, along with a warehouse for packing and storing fruit. Tom Davenport is the manager and owner of the farm, which has been in the family for several generations. The operation of the farm requires a variety of heavy machinery including 10 tractors, eight vehicles of varying sizes, a sprayer for insecticides, and a bulldozer for removing tree stumps. The warehouse also has considerable equipment for grading, sorting, and packing the fruit. Part of the warehouse is dedicated to storage and is refrigerated in an atmosphere with low oxygen content to reduce spoilage. Davenport Farms has 20 permanent employees to maintain the equipment, prune trees, apply insecticides, and irrigate the trees. During picking seasons, however, large numbers of temporary workers are hired to pick fruit and to work in the warehouse. Davenport Farms has had several successful years and Tom is considering an expansion of the farm. Recently an eight-hectare parcel adjacent to Davenport Farms has become available for sale for $100,000. The land is currently bare and would have to be developed for irrigation and planted with apple trees. Development of the land for irrigation would take several months and cost $20,000 in materials. Apple trees can be planted immediately after the land is developed. Tom assumes that his existing labor force can provide the labor for developing and planting the trees. Tom has not decided whether he would plant dwarf apple trees or full-sized apple trees. Dwarf apple trees produce fruit earlier in the sixth year after planting) and require less space 250 per hectare). The disadvantage is that dwarf apple trees do not last as long and will have to be replaced after 20 years. Full-sized apple trees begin producing in the eleventh year after planting and are replaced after 40 years, but only 125 trees can be planted per hectare. Annual cash expenses per hectare are the same for each type of tree and each type of tree generates the same quantity of apples when producing. The cost of both types of seedling apple trees is $5 per tree. Tom plans to hold the land for 40 years and then sell it for $200,000. Tom has made the following estimates of costs and benefits of buying the land and planting either dwarf or full-sized trees for the next 40 years: plan El Planting Dwarfs Planting Full Sized $ (100,000) (20,000) $ (100,000) (20,000) Land costs (now) Development costs (now) Planting costs Dwarf ($5 per tree)(250 per hectare) (8 hectares) = $10,000 (now) (10,000) 647 (10,000) (5,000) (100,000) (in 20 years) Full-sized ($5 per tree)(125 per hectare) (8 hectares) - $5,000 (now) Stump removal and disposal (in 20 years) Other cash expenses ($20,000 per year) (40 years) - $800,000 Cash revenues Dwarf: ($70,000 per year in years 6-20 and 26-40) Full-sized: ($70,000 per year in Years 11-40) Sale of land Total (800,000) (800,000) 2,100,000 200,000 $1,240,000 2,100,000 200,000 $1,275,000 Based on these estimates, the initial cash requirement to purchase and develop the land and plant dwarf trees is $130,000. If full-size trees are planted instead, the initial cost is $125,000. Tom has $40,000 of cash available to make this investment. The rest of the costs can be covered by a mortgage from the local bank. The local bank charges 10 percent interest for mortgages of this type. Tom will need to borrow $90,000 if he plants dwarf trees and $85,000 if he plants full-size trees. Tom figures his cost of capital is the interest rate that the bank charges. a. Using net present value analysis, should Tom buy the land? If so, which type of trees should he plant? b. What other factors, which are not captured in the present value analysis, should be considered in making this land acquisition? EXTENDED ANALYSIS AND INTERPRETATION PROBLEMS AIP 13.7 Davenport Farms Davenport Farms is a family-owned fruit-growing operation. The farm currently includes 120 hectares of orchards of apples, pears, and cherries, along with a warehouse for packing and storing fruit. Tom Davenport is the manager and owner of the farm, which has been in the family for several generations. The operation of the farm requires a variety of heavy machinery including 10 tractors, eight vehicles of varying sizes, a sprayer for insecticides, and a bulldozer for removing tree stumps. The warehouse also has considerable equipment for grading, sorting, and packing the fruit. Part of the warehouse is dedicated to storage and is refrigerated in an atmosphere with low oxygen content to reduce spoilage. Davenport Farms has 20 permanent employees to maintain the equipment, prune trees, apply insecticides, and irrigate the trees. During picking seasons, however, large numbers of temporary workers are hired to pick fruit and to work in the warehouse. Davenport Farms has had several successful years and Tom is considering an expansion of the farm. Recently an eight-hectare parcel adjacent to Davenport Farms has become available for sale for $100,000. The land is currently bare and would have to be developed for irrigation and planted with apple trees. Development of the land for irrigation would take several months and cost $20,000 in materials. Apple trees can be planted immediately after the land is developed. Tom assumes that his existing labor force can provide the labor for developing and planting the trees. Tom has not decided whether he would plant dwarf apple trees or full-sized apple trees. Dwarf apple trees produce fruit earlier in the sixth year after planting) and require less space 250 per hectare). The disadvantage is that dwarf apple trees do not last as long and will have to be replaced after 20 years. Full-sized apple trees begin producing in the eleventh year after planting and are replaced after 40 years, but only 125 trees can be planted per hectare. Annual cash expenses per hectare are the same for each type of tree and each type of tree generates the same quantity of apples when producing. The cost of both types of seedling apple trees is $5 per tree. Tom plans to hold the land for 40 years and then sell it for $200,000. Tom has made the following estimates of costs and benefits of buying the land and planting either dwarf or full-sized trees for the next 40 years: plan El Planting Dwarfs Planting Full Sized $ (100,000) (20,000) $ (100,000) (20,000) Land costs (now) Development costs (now) Planting costs Dwarf ($5 per tree)(250 per hectare) (8 hectares) = $10,000 (now) (10,000) 647 (10,000) (5,000) (100,000) (in 20 years) Full-sized ($5 per tree)(125 per hectare) (8 hectares) - $5,000 (now) Stump removal and disposal (in 20 years) Other cash expenses ($20,000 per year) (40 years) - $800,000 Cash revenues Dwarf: ($70,000 per year in years 6-20 and 26-40) Full-sized: ($70,000 per year in Years 11-40) Sale of land Total (800,000) (800,000) 2,100,000 200,000 $1,240,000 2,100,000 200,000 $1,275,000 Based on these estimates, the initial cash requirement to purchase and develop the land and plant dwarf trees is $130,000. If full-size trees are planted instead, the initial cost is $125,000. Tom has $40,000 of cash available to make this investment. The rest of the costs can be covered by a mortgage from the local bank. The local bank charges 10 percent interest for mortgages of this type. Tom will need to borrow $90,000 if he plants dwarf trees and $85,000 if he plants full-size trees. Tom figures his cost of capital is the interest rate that the bank charges. a. Using net present value analysis, should Tom buy the land? If so, which type of trees should he plant? b. What other factors, which are not captured in the present value analysis, should be considered in making this land acquisition

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