Consider the Vino project described in Exhibit T13.2. Suppose the government of Vino requires that you operate

Question:

Consider the Vino project described in Exhibit T13.2. Suppose the government of Vino requires that you operate a local crisis center for alcoholics. Your refusal to do so will result in a government veto of your investment project. Although the crisis center is expected to generate positive cash flow, you are not sure if it will be sufficient to compensate you for your initial investment and the of capital. The estimated cash flows associated with the crisis center are as follows:

Assume the appropriate vino-unit discount rate for the crisis center is iBV = 28% and answer the following questions:
a.What name do we attach to this type of scenario?
b.Calculate NPV0V for the Vino project without and then with this side effect. Should you accept the project described in Exhibit T14.2 if you must accept the crisis center project?
Exhibit T13.2
Wine production in Vino
U.K.Vino
Nominal risk-free government T-bill rateiF£ = 7.1%iFV =12.2%
Real required return on T-billsqF£ = 2.0%qFV = 2.0%
Expected future inflationp£ = 5.0%pV = 10.0%
Real required return on wine productioni£ = 12.0%iV = 12.0%
Current spot exchange rateS0V/£ = V10/£
The following information is known about the project:
€¢ The project has a 3-year life. Assume all operating cash flows occur at year-end.
€¢ An investment of V800, 000 will purchase the vineyard. Its real value will remain constant throughout the investment's life and the vineyard will be sold at the end of the project.
€¢ The winery and wine presses will cost V425, 000. In addition, the wine press supplier has given price quotes of V47, 500 and V27, 500 for the machinery's installation and modification, respectively. All cash outlays are payable at the start of the project.
€¢ Annual depreciation for winery and wine presses is 33%, 45%, 15%, and 7% over the four-year project. (This happens to be identical to 3-year ACRS in the United States.) The winery and presses are expected to have a total market value of V45, 000 in nominal terms at the end of the project's life in three years.
€¢ No investment in net working capital is necessary. All of the business's transactions are conducted in cash, and just-in-time inventory control will be used.
€¢ Annual sales revenues are expected to be V700, 000, V800, 000, V900, 000 in nominal terms over the next 3 years. Variable operating costs are 10% of sales. Fixed costs are V5, 000 each year in nominal terms.
€¢ Income and capital gains taxes are 50% in each country.

Discount Rate
Depending upon the context, the discount rate has two different definitions and usages. First, the discount rate refers to the interest rate charged to the commercial banks and other financial institutions for the loans they take from the Federal... Exchange Rate
The value of one currency for the purpose of conversion to another. Exchange Rate means on any day, for purposes of determining the Dollar Equivalent of any currency other than Dollars, the rate at which such currency may be exchanged into Dollars... Opportunity Cost
Opportunity cost is the profit lost when one alternative is selected over another. The Opportunity Cost refers to the expected returns from the second best alternative use of resources that are foregone due to the scarcity of resources such as land,...