Xander Harris Is Considering Whether To Buy Corn And Soybean

3xander Harris Is Considering Whether To Buy a Corn And Soybean Farm

Xander Harris is contemplating whether to purchase a corn and soybean farm in Iowa. The farm's purchase price is $800,000, which he plans to fund using inheritance from his recently deceased mother, who made her fortune on the stock market. If he chooses not to buy and continue his current job as an economic forecaster, he expects an annual income of $40,000. The prevailing interest rate is 9 percent. Xander's sole motivation is to maximize his income. The key question is whether he should buy the farm from an accounting perspective, given the likely annual profits.

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Deciding whether to invest in a farm entails evaluating the opportunity costs and potential profits associated with the decision. For Xander Harris, the central issue hinges on comparing the income generated by the farm against his current alternative, considering the financial parameters provided. From an accounting standpoint, the decision revolves around analyzing the profitability of the farm based on its projected annual profits and the cost of capital, which is represented by the prevailing interest rate. This evaluation provides insight into whether purchasing the farm will enhance his income, thereby aligning with his goal of maximizing income.

When assessing an investment such as a farm, the primary measure is whether the annual profits surpass the income he would forego by not continuing his current job, adjusted for the opportunity cost of capital. The opportunity cost for Xander is the income from his economic forecasting job, which is $40,000 annually. The initial investment of $800,000 must also be evaluated against the potential profits to determine its viability from an accounting perspective. To do this, we consider the present value of the farm's expected profits to ascertain if they sufficiently cover the investment and provide an acceptable rate of return.

Scenario Analysis

Given the scenario, the accountant indicates three different potential annual profits from the farm: $160,000, $100,000, and $50,000. In each case, the decision depends on whether these profits, when discounted at the prevailing interest rate of 9%, justify the purchase of the farm.

1. If the farm's annual profit is $160,000, the net income appears significantly higher than Xander's current salary of $40,000. To determine if the purchase is justified, we calculate the present value (PV) of the farm's profits, assuming they continue indefinitely, using the perpetuity formula: PV = Annual Profit / Interest Rate. This results in a PV of approximately $1,777,778 ($160,000 / 0.09), which exceeds the purchase price of $800,000 by a substantial margin, indicating a highly profitable investment from an accounting standpoint. The opportunity cost of not buying the farm is the forgone profit, which is outweighing the current forecaster salary, making the purchase advisable.

2. When annual profits are $100,000, the PV calculation yields approximately $1,111,111 ($100,000 / 0.09). This still exceeds the initial investment, although less dramatically than the previous scenario. The farm's profit margin remains sufficient to justify the purchase, considering the opportunity costs. From an accounting perspective, this profit level makes the investment attractive, as the present value of future profits surpasses the initial investment, and the additional income significantly exceeds his current salary.

3. If the farm's annual profit diminishes to $50,000, the PV calculates to approximately $555,556 ($50,000 / 0.09). While this is still over the initial purchase price, the margin is narrower. The decision then depends on whether Xander values the farm's additional income over his current job, considering risks and other qualitative factors. From a strict accounting viewpoint, the investment remains feasible, but the profitability margin is less comfortable, and the decision may hinge on other factors such as risk preferences and personal valuation of farm ownership.

Conclusion

From an accounting standpoint, the decision to buy the farm depends critically on the predicted annual profits and the present value of those profits relative to the purchase price. In all three scenarios—$160,000, $100,000, and $50,000—the present value of the profits exceeds the $800,000 cost, suggesting that the investment is financially justifiable. The highest profit level ($160,000) offers the most convincing case, followed by the $100,000 scenario. Even at the lowest profit estimate ($50,000), purchasing the farm appears to be favorable solely based on generating returns above the cost of capital. Ultimately, Xander should proceed if his sole objective is to maximize income from an accounting perspective, assuming these profit estimates hold true.

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