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Alan’s Tree Garden, SDN BHD Alan’s Tree Garden, SDN BHD is doing well after its incorporation

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Alan’s Tree Garden, SDN BHD Alan’s Tree Garden, SDN BHD is doing well after its incorporation. Suresh Kumar, president, chief of operations, and majority shareholder, currently has a planting of 10,000 three-year-old Japanese dogwood trees in a recently introduced white-flowered variety. Kumar can sell this type of tree at a higher price than the more common red-flowered variety. The trees are now 6 feet tall on average and can command RM24 each. At present, Kumar has priced 8-foot trees at RM34 and 10-foot trees at RM40. Landscape contractors avoid trees larger than 10 feet tall because they are difficult to transplant successfully. With average weather, the 6-foot trees will be 8 feet tall in three years and 10 feet tall in six years. Suresh has to make financial decisions almost every day. Today’s decision involves present value and future value computations, which Jake learned as a student at SEGi University. He wants to know if he should sell the trees immediately at 6 feet tall, three years from now at 8 feet tall, or six years from now at 10 feet tall. Size Age Current Market Value 6` 3 years RM24 8` 6 years RM34 10` 9 years RM40

QUESTION 1 Because of inflation, Suresh expects the price at which he can sell the trees to increase by 3% per year. What price does he expect to receive if he keeps the trees until they reach 8 feet or 10 feet tall?

Compute and evaluate the answer. (10 marks)

QUESTION 2 If Suresh discounts the future price of the trees at 10% per year, what is the present value of their future prices?

Compute and evaluate the answer. (10 marks)

QUESTION 3 Using the time value of money equation, compute the growth rate of the trees between the third year and the sixth year and between the sixth year and the ninth year. Compute and evaluate the answer. (10 marks) 5

Question 4 When should Suresh sell the trees? Critically evaluate your answer. (10 marks)

Question 5 A major landscape contractor who has bid successfully on a large-scale Ipoh beautification and urban greening project has offered to buy all 10,000 flowering dogwood trees at a price of RM28,000, payable immediately. However, the contractor does not need the trees for three years. If Suresh accepts, he will be obliged to deliver 10,000 trees three 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 Suresh accept the offer if his required rate of return is 10%? Discount the price at 10%. Critically evaluate the answer.

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Given Information:

Market Price of Trees today:

Size of Tree	Age	Current Market Value
6 feet	3 years	RM 24
8 feet	6 years	RM 34
10 feet	9 years	RM 40

Inflation rate = 3% per year

Discounting rate = 10% per year

Solution to 1: Selling price of the trees at 8 feet & 10 feet:

8 feet tree:

Current selling price of a 8 feet tree = RM 34

The 6 feet trees will take 3 years to become 8 feet tall. The increase in price of the tree is 3% per year. Hence, expected selling price of the 8 feet tree, 3 years from now will be:

Selling price today * (1 + increase %) ^ no. of years

i.e. Expected Selling Price = Current Price * (1 + i)ⁿ

[(1 + i) represents the increase in price per year. As the total growth period is 3 years, we multiply the current price by (1 + i) 3 times i.e. (1 + i)ⁿ ]

Current price = RM 34

i = 3% or 0.03

n = 3 years

$\therefore$ Expected Selling Price = RM 34 * (1 + 0.03)³

$\therefore$ Expected Selling Price = RM 34 * (1.03)³

$\therefore$ Expected Selling Price = RM 34 * 1.092727

$\therefore$ Expected Selling Price = RM 37.15

10 feet tree:

Current selling price of a 8 feet tree = RM 40

The 6 feet trees will take 6 years to become 10 feet tall. The increase in price of the tree is 3% per year. Hence, expected selling price of the 10 feet tree, 6 years from now will be:

Selling price today * (1 + increase %) ^ no. of years

i.e. Expected Selling Price = Current Price * (1 + i)ⁿ

[(1 + i) represents the increase in price per year. As the total growth period is 6 years, we multiply the current price by (1 + i) 6 times i.e. (1 + i)ⁿ ]

Current price = RM 40

i = 3% or 0.03

n = 6 years

$\therefore$ Expected Selling Price = RM 40 * (1 + 0.03)⁶

$\therefore$ Expected Selling Price = RM 40 * (1.03)⁶

$\therefore$ Expected Selling Price = RM 40 * 1.194052

$\therefore$ Expected Selling Price = RM 47.76

Solution to 2: Calculation of present value of future prices:

The discount rate is assumed to be 10%. To calculate the present value of future prices, the expected future prices will be discounted by 10% for 3 years (for 8 feet tall trees) & by 6 years (for 10 feet tall trees).

8 feet tree:

Expected future price = RM 37.15

Discount rate (r) = 10% or 0.1

No. of years of discounting (n) = 3 years

Present Value = $\frac{Future Price}{(1 + r)^{n}}$

$\therefore$ Present Value = $\frac{37.15}{(1.1)^{3}}$

$\therefore$ Present Value = RM 27.91

10 feet tree:

Expected future price = RM 47.76

Discount rate (r) = 10% or 0.1

No. of years of discounting (n) = 6 years

Present Value = $\frac{Future Price}{(1 + r)^{n}}$

$\therefore$ Present Value = $\frac{47.76}{(1.1)^{6}}$

$\therefore$ Present Value = RM 26.96

Solution to 3: Growth rate of trees between 3rd to 6th year & 6th to 9th year:

Growth rate between 3rd to 6th year:

Selling price of 6 feet tree = RM 24

Selling price of 8 feet tree = RM 34

The 6 feet tree will take 3 years to become a 8 feet tree. Hence, the growth rate (g) will be calculate assuming RM 24 to be present value (P.V.) & RM 34 the future value (F.V.).

P.V. * (1 + g)ⁿ = F.V.

$\therefore$ 24 * (1 + g)³ = 34

$\therefore$ (1 + g)³ = 34 / 24 = 1.41667

$\therefore$ (1 + g) = $\sqrt[3]{1.41667}$

$\therefore$ (1 + g) = 1.1231

$\therefore$ g = 0.1231 or 12.31%

Growth rate between 6th to 9th year:

Selling price of 8 feet tree = RM 34

Selling price of 10 feet tree = RM 40

The 8 feet tree will take 3 years to become a 10 feet tree. Hence, the growth rate (g) will be calculate assuming RM 34 to be present value (P.V.) & RM 40 the future value (F.V.).

P.V. * (1 + g)ⁿ = F.V.

$\therefore$ 34 * (1 + g)³ = 40

$\therefore$ (1 + g)³ = 40 / 34 = 1.17647

$\therefore$ (1 + g) = $\sqrt[3]{1.17647}$

$\therefore$ (1 + g) = 1.0556

$\therefore$ g = 0.0556 or 5.56%

Solution to 4: When should suresh sell the trees?

Analysis of selling prices & growth rate:

Size of the tree	Current Selling price	Expected Future Price	Present Value of Future Price	Growth rate of prices
6 feet	RM 24	N.A.	N.A.	N.A.
8 feet	RM 34	RM 37.15	RM 27.91	12.31%
10 feet	RM 40	RM 47.76	RM 26.96	5.56%

8 feet tree:

The present value of expected selling price of the 8 feet tree is RM 27.91. Compared to the current price of 6 feet tree i.e. RM 24, the present value is higher by RM 3.91 (RM 27.91 - RM 24). The growth rate of increase in price of the trees is 12.31%, which is higher than the discount rate of 10% i.e. the appreciation of price of tree is greater than the discount rate. Hence, it will be advantageous for Suresh to sell the trees after growing them to 8 feet & selling at the expected price of RM 37.15.

10 feet tree:

The present value of expected selling price of the 10 feet tree is RM 26.96. Compared to the current price of 6 feet tree i.e. RM 24, the present value is higher by RM 2.96 (RM 26.96 - RM 24). However, this is lower than the increase in price from 6 feet to 8 feet tree.

Also, the growth rate of increase in price of the trees is only 5.56% between the 8 feet to 10 feet tree, which is lower than the discount rate of 10%.

Hence, although it is advantageous for Suresh to sell the trees after growing them to 10 feet, he will be better off by growing them to 8 feet only & selling at the expected price of RM 37.15.

Alan’s Tree Garden, SDN BHD Alan’s Tree Garden, SDN BHD is doing well after its incorporation

Finance