Windy Burgers is trying to determine when to harvest a herd of cows that it currently owns. If it harvests the herd in year 1, the NPV of the project would increase over an immediate harvest by 25 percent. A year 2 harvest would create an NPV increase of 15 percent over that of year 1 and year 3 would create an NPV increase of 7 percent over that of year 2. If the cost of capital is 12 percent for Windy, then which harvest year would maximise the NPV for the company? Assume that all NPVs are calculated from the perspective of today.

Question

Quizplus · Accepted Answer

To determine the optimal harvest year, we need to calculate the NPV of each year and compare them.

If we harvest immediately, the NPV is 0 since there is no increase in NPV.

If we harvest in year 1, the NPV will increase by 25%, so the NPV will be:

NPV1 = 0 + (0 x 0.25) = 0

If we harvest in year 2, the NPV will increase by 15% over that of year 1, so the NPV will be:

NPV2 = 0 + (NPV1 x 0.15) = 0 + (0 x 0.15) = 0

If we harvest in year 3, the NPV will increase by 7% over that of year 2, so the NPV will be:

NPV3 = 0 + (NPV2 x 0.07) = 0 + (0 x 0.07) = 0

Therefore, the optimal harvest year would be year 2, as it provides the highest NPV increase (15%).

Windy Burgers Is Trying to Determine When to Harvest a Herd