Question

You own a 10-acre vineyard and earn income by selling your grapes to wineries. Your vineyard is currently planted to Merlot grapes, but you are thinking of replanting with Syrah grapes because they are commanding a higher market price per ton. Merlot fetches $1700 per ton but Syrah sells for $2600 per ton, those prices are expected to remain stable, and you produce 50 tons per year. Either way, you plan to sell the vineyard 5 years from today (at the end of the year) for 5-times (5x) the annual income (in year 5) from the sale of grapes (that is, you'll get the income from grape sales and then sell the vineyard for 5 times that amount at the end of year 5). However, if you were to switch to Syrah, switching will cost you $97,000 today and the vines won’t produce any grapes until the end of year 4 (that is, years 1 - 3 will have no sales if you plant Syrah, but years 4 and 5 will). The applicable discount rate is 11% per year. What is the NPV of switching? Round to the nearest cent. ​[Hint: Create a timeline showing the incremental annual cash flows from switching and find their NPV. Some cash flows will be negative (first 3 years) and some will be positive (years 4 and 5)]

Answer 1

Please refer to the attached xls screenshot.

Soluiton: NPV gets lower if switched from merlot to sarah , hence Switching is not profitable.

Formula:

B C D 44 45 Merlot 1700 50 Syrah 2600 50 46 per ton 47 production 48 Field sale X 49 switch cost 50 Discount 51 -97000 11% 1 2 3 4 130000 5 130000 53 Year 54 Sales 55 Vineyard sale 56 Net cash 57 NPV 58 Total NPV 59 Net NPV 650000 130000 780000 85635.03 462892 548527.06 451527.06 61 Year 62 Sales 63 Vineyard sale 64 Net cash 65 NPV 66 Net NPV 67 85000 85000 85000 85000 85000 425000 85000 85000 85000 85000 510000 76577 68987.91 62151.27 55992.13 302660.2 566368.06

Updated: