Question

1) You want to start an organic garlic farm. The farm costs $190,000, to be paid in full immediately. Year 1 cash inflow will be $25,000, after which the inflows are expected to grow at a 5% annual rate until the end of year 5 when you anticipate selling the farm for $300,000 (at the end of year 5 you get both the cash inflow from operations and from selling the farm). What is the IRR of your garlic farm investment? Round to the tenth of a percent (e.g. 5.6%=5.6). ​[Hint: You'll want to solve this in Excel using the IRR function or Goal Seek. Make sure the IRR cell is set to show decimals.]

2) 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 $1500 per ton but Syrah sells for $2800 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 4-times (4x) 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 4 times that amount at the end of year 5). However, if you were to switch to Syrah, switching will cost you $111,000 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 9% 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

1]

Cash outflow in year 0 = cost of farm = $190,000

Cash inflow in years 1 to 4 =  cash inflow from operations

Cash inflow in year 5 =  cash inflow from operations + selling price of farm

IRR is 21.78%

IRR is 21.78%