Valuing a Texas Vineyard (Real Options Analysis using binomial tree and DCF model.) You have been asked by an entrepreneur to value a potential vineyard in the Texas Hill Country, an area west of Austin, Texas, USA. The cost of establishing a vineyard is reported in Table 1 below. The cost of operating a vineyard is given in Table 2 below. The current price of the relevant grapes is $1,500/tn. Historically, grape prices have grown on average by 3.5% per year and the standard deviation of the log-returns on Texas grapes has, historically, been 10%. Your client uses a WACC of 12% for similar projects but is unsure whether this would be an appropriate RADR for this project. The land that your client is thinking of purchasing has a yield of 4 tons of grapes per acre. Yields are not expected until 3 years after the land has started to be cultivated. Capital expenditure is depreciated linearly over 10 years, and the corporate tax rate is 37.5%. You are asked to advise on the optimal time to invest in a winery. In your analysis, use a 10-step binomial tree, the probability of success in the first year is 21%. for the next steps you should come up with the probabilities (using clear assumptions). Table 1: Required investment to establish a vineyard ($/acre) Item Year 1 Year 2 Year 3 Land purchase 2,500 Equipment 2,000 Site preparation & planting 4,400 Trellis construction 3,500 Drip irrigation & install 1,300 Cultural practices 1,800 1,800 1,800 Table 2: Average Annual Operating Costs ($/acre) Item Cost Chemical cost 622 Labour 2,500 Harvesting 300 Maintenance/repairs 424 Irrigation/fuel 113