HealthyLife Farm is a farm and it grows corn for commercial use as an important gasoline additive. Each year, the farm plants thousands of acres of corn, which is eventually harvested and sold to gasoline processing plants. The farm is faced with a new corn field investment opportunity which involves developing and producing 300,000 bushels of corn under the most likely scenario. Corn is currently trading at 6.5 dollars per bushel; the price next year, when the corn is harvested, could be as high as 8 dollars per bushel or as low as 5 dollars per bushel. Furthermore, the forward price of corn one year later is currently 7 dollars per bushel. If the farm acquires the new investment, the farms analysts are confident that it will face a cost of 4.5 dollars per bushel to grow the corn.

The new corn field investment involves a bank loan of $0.2 million with 10% interest rate compounded annually due for repayment in one year. The loan is secured by the property. If the farm buys the corn field, it will have to assume this bank loan and responsibility for repaying it. However the loan is nonrecourse; if the owner of the property decides not to develop the property in one year, the owner can simply transfer ownership of the property to the lender. The asking price for the equity in the corn field is $0.5 million. The problem for HealthyLife Farm is whether this investment is worth this amount. The risk-free rate is assumed to be 5%. Answer the following questions assuming zero taxes.

1. Estimate the value of the equity in the project for the case where all the corn is sold forward at the 7 dollars per bushel price. Should this investment be made in this case?

2. In this question, the farm can use the forward contract to hedge the corn price uncertainty. In reality, the forward contract cannot eliminate all the risk that the owner of the corn field will face. List out two reasons why the use of forward contract cannot eliminate all the investment risk.