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 $2700 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 $100,000 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

A. Calculation of NPV of switching :

Conclusion: NPV of switching the breed of grapes results in negative NPV. Hence, it should not be considered.