Taking Buying Decision With Cost Of Capital

Question

The timber rights to a tract of forest can be purchased for $90,000. The harvesting agreement would allow 25% of the timber to be cut in each of the first, second, fourth and fifth years. The purchaser of the timber rights would be required to replant, at its expense, the logged areas in Years 3 and 6. Arrowsmith Lumber calculates that its profit in each of the 4 cutting years would be $50,000 and that the cost of replacing the harvested areas in each Years 3 and 6 would be $20,000.

a. Should Arrowsmith Lumber buy the timber rights if its cost of capital is 18%?

b. By what amount would the economic value of Arrowsmith Lumber be increased or decreased if it proceeded with purchasing the timber rights for $90,000?

Summary

The question belongs to Accounting and it discusses about calculation of whether or not to take buying decision.

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