Problem:
Sherry Bishop of Thayer Industries is considering investing in a capital project that costs $1.2 million. The project is expected to generate after-tax operating cash flows equal to $500,000 in the first year and declining by $100,000 per year until the end of the project's life in five years. Assume that Thayer's nominal discount rate for this project is 12% and that the annual inflation rate is 3%.
(1) Calculate the project's NPV, assuming that the project's cash flow are given in nominal terms. Would you accept this project?
(2) Calculate the real values of future cash flows.
(3) Recalculate the project's NPV, using the real cash flows and the appropriate real discount rate. Does your accept-reject decision change from your answer in part (1)?