Question

A major landscape contractor, who has bid successfully on a large-scale Boston beautification and urban greening project, has offered to buy all 10,000 of the flowering dogwood trees at a price of $28,000, to be paid immediately. The trees, however, will not be needed for three years. If Jake accepts, he will be obliged to deliver 10,000 trees 3 years from today. If anything should happen to his own crop, he would need to buy trees on the open market at the prevailing price, which might be higher or lower than the price estimated in question 1. Should Jake accept the offer if his required rate of return is 10%?

Answer 1

Jake should calculate the present value of $28,000 at his required rate of return of 10% over three years. If the present value is greater than or equal to the cost of producing or buying the trees on the open market in three years, he should accept the offer.

Step-by-step explanation:

The student's question deals with a financial decision-making scenario where Jake has to decide whether to accept an offer to sell 10,000 flowering dogwood trees at a price of $28,000, which would be paid immediately, but delivery is expected in three years. In assessing whether Jake should accept the offer, we need to determine if the present value of the offer equals or exceeds Jake's cost, including his required rate of return of 10%. The key to making a sound decision involves calculating the present value of the offer using discount rates and comparing it with the future cost of delivering the trees, potentially at a higher market price.

To analyze if the offer is favourable, Jake should calculate the present value of $28,000 using the formula for present value:

PV = FV / (1 + r)^n

where PV is the present value, FV is the future value ($28,000), r is the annual discount rate (10%), and n is the number of years (3). If the calculated present value is greater than or equal to the cost of producing or possibly buying the trees on the open market in three years, he should consider accepting the offer. However, if the present value is less than the cost, it would not meet his required rate of return and accepting the offer may not be financially sound.