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Name___________________________________ Lab Section___________________________________ Agricultural Economics 278 Final Examination Fall 2005 INSTRUCTIONS I. Multiple Choice - 2 points each – Circle the letter corresponding to the one best answer 40 points II. Problems - points per question as indicated in ( ) - answer the questions in the problem sets and show work 45 points as requested III. Short Answer - points per question as indicated in ( ) - provide a concise, yet complete answer to each question 15 points Total Points 100 Which one of the following tools is commonly used to select enterprise levels in the whole farm plan? a. cash flow budget b. enterprise budget c. income statement d. linear programming In whole farm planning, the resource requirements to produce 1 acre of a crop or 1 head of livestock is called: a. an enterprise budget b. a technical coefficient c. an income assessment d. gross margin Gross margin as used in whole farm planning is defined as: a. total income minus total variable costs b. total income minus total fixed costs c. total income minus total costs d. total income minus total variable and total fixed costs Estimating the expected income, expenses, and profit for a given whole farm plan is: a. the cash flow budget b. the balance sheet c. the whole farm budget d. an investment analysis A dollar borrowed plus the interest paid for borrowing the dollar of capital measures: a. the return on an investment b. the marginal input cost (MIC) of capital c. interest expense for the income statement d. total variable cost of borrowing money The largest source of capital for farm businesses is: a. the owners’ equity capital b. sources of credit c. government loans d. money borrowed from family members Assume you have a $150,000 line of credit with your local bank for annual operating expenses with an interest cost of 6 percent. You borrow $100,000 against the line of credit on March 1 for spring planting, and repay $65,000 on September 1 when some wheat is sold. How much of the $65,000 payment will be assigned to interest? a. $65,000 b. $6,000 c. $3,000 d. $650 The most powerful tool for determining the exact time money will need to be borrowed during a given year is likely: a. the income statement b. the cash flow budget c. the whole farm budget d. the balance sheet Which one of the following statements best describes what is meant by tax avoidance with regard to income tax management for the agribusiness firm? a. tax avoidance is illegal and subject to criminal prosecution b. income taxes cannot be avoided and managing taxes is a waste of management time c. tax avoidance is a legal management strategy to increase after tax income d. tax avoidance is paying the least amount of income taxes possible Assume your cash flow budget shows a month when your cash outflows exceed your cash inflows. What is the appropriate management response? a. terminate the business as it has become insolvent b. plan for a negative net income at the end of the year c. sell fixed assets to deal with the cash shortfall d. arrange to secure additional cash for that month and continue to operate the business Which one of the following describes the relationship between the cash flow budget and the income statement? a. the two are the same b. the cash flow budget shows net income before fixed costs c. the cash flow budget shows net income from a single enterprise d. none of the above are true Part of your 2005 calf crop is currently being maintained in a feedlot for sale in March of 2006. How will this expected sale be reflected on your 2005 cash flow budget? a. would be a cash inflow for December 2005 since the calves were produced in 2005 b. would be a cash outflow for December 2005 since the calves have not been sold c. would be a cash inflow for February of 2005 since that is when the calves were born d. the sale of the calves would not be included on the 2005 cash flow budget Which one of the following would not be included in your cash flow budget? a. depreciation b. interest payments c. scheduled repayments of principal on debt d. payment for a fixed expense like insurance Based on the time value of money, a dollar received today is: a. worth the same as a dollar received sometime in the future b. worth less than a dollar received sometime in the future c. worth more than a dollar received sometime in the future d. cannot tell from the information provided For investment analyses, present value (PV) of a sum refers to: a. the current value of some amount to be received in the future b. the value of a dollar received today at some specified point in the future c. a fixed payment for a specified period of time d. all of the above define present value of a sum When doing investment analysis for your business, the appropriate interest rate is: a. the prime interest rate b. the prime interest rate plus 2 percent c. the interest rate received on a insured savings account d. it depends Which of the following can influence the future value of a current sum? a. the interest rate b. the amount of the current sum c. the length of time being considered d. all of the above are true When borrowing money using an amortized repayment schedule and assuming the same annual percentage rate (APR) and time to repay, which of the following loan types will have the lowest total interest cost? a. an equal principal payment loan b. an equal payment loan c. an interest only loan with a balloon principal payment at the end of the loan d. total interest cost would be the same for all three loans based on the same APR Using the “Rule of 72,” $100 invested at 6 percent would double in approximately how many years? a. 20 years b. 12 years c. 6 years d. 4 years For income tax purposes, which of the following is true about the use of a cash or an accrual accounting system for a farm business? a. once selected, changing requires permission of the Internal Revenue Service b. farm businesses must use a cash accounting system c. farm businesses must use an accrual accounting system d. a farm business can switch between cash and accrual every year depending on which one minimizes income taxes due For income tax purposes, a net operating loss (NOL) in a farm business: a. can be carried forward or backward, but the taxpayer must select which b. can be carried forward for 20 years c. can be carried backward for 5 years d. all of the above are true The Net Present Value (NPV) of an investment is defined as: a. the time period (in years) it takes to recover the cost of an investment b. the interest rate needed for leverage to be effective c. the sum of the present value for each year’s net cash flow minus the initial cost of the investment d.. the sum of the present value for each year’s net cash flow plus the initial cost of the investment Interest on a single payment loan of $100,000 to be paid back in 3 months using an annual percentage rate of 6 percent would be: a. $6,000 b. $1,500 c. $1,000 d. $ 500 What is the primary goal of effective income tax management for a well managed business? a. minimize income tax paid b. make sure total taxes paid are zero c. maximize after tax income d. evade income taxes whenever possible Assume you pay $10,000 for a piece of equipment and depreciate the equipment using the expensing option in the year of purchase under Section 179. The tax basis for this piece of equipment after it has been owned for three years would be: a. $10,000 b. $5,000 c. $1,000 d. $0.00 Section II. Problems 1. Use the following information on marginal tax rates for a married couple filing a joint return for their farm business to answer the following two questions: Marginal Taxable Income Tax Rates $0 – $15,000 10.0% $15,001 – $60,000 15.0% $60,001 - $120,000 25.0% $120,001 - $180,000 28.0% Assume the farm business is expected to have $135,000 in taxable income over the next 3 years. Without tax planning, normal variability in income would generate a taxable income stream of: $15,000 in year 1; $105,00 in year 2; and $15,000 in year 3. With planning, the farm owners could equalize their taxable income to be $45,000 for each of the three years. a. What is the expected income tax to be paid for the three years from each alternative stated above (ignore the impact of the self-employment tax for Social Security and Medicare)? Show work! (8) b. What is the average tax rate on the total income of $135,000 over the three years for each of the 2 alternative taxable income streams above? Show work! (4) 2. Tables 2 through 5 provided should be used to answer the following questions. a. Determine the NPV of the following two investments. Use a discount rate of 7.0 percent and assume a residual value of 0. Show work! (10) Investment A Investment B Initial cost = $15,000 Initial cost = $15,000 Net Cash Flow Net Cash Flow Year 1 $10,000 $5,000 Year 2 $5,000 $5,000 Year 3 $3,000 $5,000 Year 4 $ 0 $5,000 NPV of Investment A ______________ NPV of Investment B_______________ b. Which of the two alternative investments would you choose using the NPV evaluation method, and what other factor might you want to consider in the decision? (4) c. Assume the residual value of investment A is $1,500 at the end of year 4, and Investment B’s residual value remains at zero. Would that change your calculation of NPV (I am looking for a precise dollar amount) and would your decision change? Show work! (3) d. What is the payback period for investment B? Show work! (3) 3. Feel free to use the equal payment amortization table provided to help answer the following three questions. Assume you borrow $40,000 to buy a new pickup for your farm business at an interest rate of 7.5 percent for 5 years with five annual payments at the end of each year. a. Show the loan repayment schedule (total payment amount) over the five years assuming it is an equal payment loan. (4) b. Show the loan repayment schedule (total payment amount, principal payment, and interest payment) over the five years assuming it is an equal principal payment with principal and interest due at the end of each year. (6) c. How much more total interest is paid with the equal payment loan (show the dollar amount), and why is total interest higher on equal payment loan? Show work! (3) Section III – Essay 1. What factors are important in choosing the structure of a loan that is to be used to start an agribusiness firm (your should be able to come up with three)? (6) 2. Other than owner’s equity, what are two sources of capital available to finance an agribusiness firm? (4) 3. What is the difference between ordinary income and capital gain income for a farm business, and why would a manager prefer to have income classified as capital gain income rather than ordinary income? (5)