Wine production in Vino

U$.$K$.$ Vino

Nominal risk$-$free government T$-$bill rate iF$=7\mathrm{.}1\%$ iFV $=12\mathrm{.}2\%$

Real required return on T$-$bills qF$=2\mathrm{.}0\%$ qFV $=2\mathrm{.}0\%$

Expected future inflation p$=5\mathrm{.}0\%$ pV $=10\mathrm{.}0\%$

Real required return on wine production i$=12\mathrm{.}0\%$ iV $=12\mathrm{.}0\%$

Current spot exchange rate S$0$V$/=$ V$10/$

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 V$800,000$ 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, wine presses, and installation will cost V$500,000.$ 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 V$45,000$ 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 V$700,000,$ V$800,000,$ V$900,000$ in nominal terms over the next $3$ years. Variable operating costs are $10\%$ of sales. Fixed costs are V$5,000$ each year in nominal terms.

Income and capital gains taxes are $50\%$ in each country.

a$.$ Suppose the international parity conditions do not hold. In particular, assume real rates q$=0\mathrm{.}0\%$ and qV $=12\mathrm{.}0\%,$ and inflation p$=17\mathrm{.}6\%$ and pV $=10\mathrm{.}0\%,$ so that nominal interest rates are i$=17\mathrm{.}6\%$ and iV $=23\mathrm{.}2\%$ from the Fisher equation. In addition, the expected spot rate is assumed to hold its nominal value such that E$[$St$/$V$]=0\mathrm{.}10/$V in years $1$ through $3.$ Calculate V$.$ Should you invest in the project? How do you respond to this market disequilibrium?