Question

A wine lover has decided to start a winery. The initial investment will be $5 million on Day 1. The winery will require an additional $1 million dollars investment at very beginning Year 1. The vines will mature over five years. Beginning at the end of year 6, the winery is expected to produce net cash inflows of $2 million, 4 mil in year 7, 6 mil in year 8, 8 mil in year 9 and 10 mil in year 10. What is the NPV, IRR, and Payback (non- discounted and discounted) assuming a discount rate of 15 percent?

Answer 1

NPV = PV of Cash Inflows - PV of Cash Outflows

Year	CF	PVF@15%	Disc CF
0	$    -6.00	1.0000	$    -6.00
1	$          -	0.8696	$          -
2	$          -	0.7561	$          -
3	$          -	0.6575	$          -
4	$          -	0.5718	$          -
5	$          -	0.4972	$          -
6	$      2.00	0.4323	$      0.86
7	$      4.00	0.3759	$      1.50
8	$      6.00	0.3269	$      1.96
9	$      8.00	0.2843	$      2.27
10	$   10.00	0.2472	$      2.47
NPV	$      3.08

Part B:

IRR is the Rate at which PV of Cash Inflows are equal to PV of Cash outflows

Year	CF	PVF@15%	Disc CF	PVF @21%	Disc CF
0	$    -6.00	1.0000	$    -6.00	1.0000	$    -6.00
1	$          -	0.8333	$          -	0.8264	$          -
2	$          -	0.6944	$          -	0.6830	$          -
3	$          -	0.5787	$          -	0.5645	$          -
4	$          -	0.4823	$          -	0.4665	$          -
5	$          -	0.4019	$          -	0.3855	$          -
6	$      2.00	0.3349	$      0.67	0.3186	$      0.64
7	$      4.00	0.2791	$      1.12	0.2633	$      1.05
8	$      6.00	0.2326	$      1.40	0.2176	$      1.31
9	$      8.00	0.1938	$      1.55	0.1799	$      1.44
10	$   10.00	0.1615	$      1.62	0.1486	$      1.49
NPV	$      0.35		$    -0.08

IRR = Rate at which least +ve NPV + [ NPV at that rate / Change in NPV due to 1% inc in disc Rate ] * 1%

= 20% + [ 0.35 / 0.43 ] * 1%

= 20% + 0.82%

= 20.82%

Part C:

Payback period is the period in which initial investment is recovered.

Initial investment $ 6M

Amount recovered in Year 6 & 7 together is $ 6 M

Thus Payback period is 7 years.