Problem: The following information is available about an investment opportunity. Investment will occur at time 0 and sales will commence at time 1.
Initial cost $10 million
Unit sales 100,000
Selling price per unit, this year $50
Variable cost per unit, this year $20
Life expectancy 10 years
Salvage Value $0
Depreciation straight-line
Tax rate 34%
Nominal discount rate 10%
Real discount rate 10%
Inflation rate 0%
Q1. Prepare a spreadsheet to estimate the project's annual after-tax cashflows.
Q2. Calculate the investment rate of return and its NPV.
Q3. How do your answer to questions (a) and (b) change when you assume a uniform inflation rate of 8% percent a year over the next 10years? (use the following equation to calculate the nominal discount rate: In = (1+Ir)(1+p)-1, where In is the nominal discount rate , Ir, is the real discount rate, and p is the expected inflation.)
Q4. How do you explain the fact that inflation causes the internal rate of return to increase and the net present value to address?
Q5. Does inflation make this investment more attractive or less attractive? why?