70.2K

Verified Solution

Link Copied!

Consider the following Example: Example 2.4(When to cut a tree) Suppose that you have the opportunity to plant trees that later can be sold for lumber. This project requires an initial outlay of money in order to purchase and plant the seedlings. No other cash flow occurs until the trees are harvested. However, you have a choice as to when to harvest: after 1 year or after 2 years. If you harvest after 1 year, you get your return quickly; but if you wait an additional year, the trees will have additional growth and the revenue generated from the sale of the trees will be greater. We assume that the cash flow streams associated with these two alternatives are (a) (-1,2) cut early (b) (-1,0,3) cut later. We also assume that the prevailing interest rate is 10%. Then the associated net present values are (a) NPV =-1+2/1.1 = .82 (b) NPV = -1+3/(1.1)2 = 1.48. Hence according to the net present value criterion, it is best to cut later. Now suppose you learn that a third option is possible: you may delay cutting the trees for another 2 years, thus harvesting after 4 years. You are told that, from a present value perspective, it is not worthwhile to do so. If this is true, the revenue obtained when cutting trees after 4 years must be less than x. What is x? Please round your numerical answer to 1 decimal place

Answer & Explanation Solved by verified expert

See Answer