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You have the one-time opportunity to plant trees that later can be sold for lumber. This project requires an initial outlay of money in order
You have the one-time 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 seedlings. You have a choice as to when to harvest: after 1 year or after 2 years. We assume the following cash flow streams for these choices: (Choice 1) Cut early: (-1, 1.3) (Choice 2) Cut later: (-1,0, 1.6) Here, in the case of Choice 1 (cut early), you make an arrangement to lend your proceeds from the tree farming business for one year (from year 1 to year 2) with the prevailing interest rate since these investment opportunities cannot be repeated (that is, they are one-time opportunities). (a) Assume that the 1-year spot rate s and 2-year spot rate s2 are both 10%. Then, assuming yearly compounding, evaluate the two choices ("cut early" and "cut later) by comparing the final outcome at the end of 2 years. Describe your conclusion. (b) Now assume that s = 10% and s2 = 20%. Evaluate the two choices based on the final outcome. Describe your conclusion. (c) Assume that su = 10%. Then, what is the break-even 2-year spot rate which makes the two choices equivalent
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