Question

Pl be unique and mention every formula and details.

You are interested in an investment project that costs $44,625 initially. The investment has a 5-year horizon and promises future end-of-year cash inflows of $11,900, $12,495, $11,305, $8,925, and $8,330, respectively. Your current opportunity cost is 6.83% per year. However, the Fed has stated that inflation may rise by 1.5% or may fall by the same amount over the next 5 years.

Assume a direct positive impact of inflation on the prevailing rates (Fisher effect) and answer the following questions: (Assume that inflation has an impact on the opportunity cost, but that cash flows are contractually fixed and are not affected by inflation.)

a) What is the net present value (NPV) of the investment under the current required rate of return?

b) What is the net present value (NPV) of the investment under a period of rising inflation?

c) What is the net present value (NPV) of the investment under a period of falling inflation?

d) From your answers in (a), (b), and (c), what relationship do you see emerge between changes in inflation and asset valuation?

Answer 1

working note -1 G2=1/1.683

d4 = first option at the end of first year

	0.0683	=1/1
years	option -1 at current inflation rate	option-2 at increase in infaltion rate	option-3 derease in infaltion rate
1	=1/1.683	=+D4*1.015	=+E4*1.015
2	=+D4*$G$2	=+D5*1.015	=+E5*1.015
3	=+D5*$G$2	=+D6*1.015	=+E6*1.015
4	=+D6*$G$2	=+D7*1.015	=+E7*1.015
5	=+D7*$G$2	=+D8*1.015	=+E8*1.015
after above calculation	the resultant figures are as	folllows
	6.83%	1
years	option -1 at current inflation rate	option-2 at increase in infaltion rate	option-3 derease in infaltion rate
1	0.594177065	0.6030897	0.6121361
2	0.353046384	0.3583421	0.3637172
3	0.209772064	0.2129186	0.2161124
4	0.124641749	0.1265114	0.128409
5	0.074059269	0.0751702	0.0762977
after attaining table value	we need to calculate discounted	cash inflows asa follows
			solution for a			solution for b			solution for c
		option-1		option-2			option-3
initial out flow	A		-44625			-44625			-44625
cash inflows	cash inflows(1)	discount rate (2)	Discounted inflows(1*2)	cash inflows(3)	discount rate (4)	Discounted inflows(3*4)	cash inflows(5)	discount rate (6)	Discounted inflows(5*6
year 1	11900	0.594177065	7070.707	11900	0.603089721	7176.77	11900	0.612136067	7284.42
year2	12495	0.353046384	4411.315	12495	0.35834208	4477.48	12495	0.363717211	4544.65
year 3	11305	0.209772064	2371.473	11305	0.212918645	2407.05	11305	0.216112425	2443.15
year 4	8925	0.124641749	1112.428	8925	0.126511376	1129.11	8925	0.128409046	1146.05
year 5	8330	0.074059269	616.9137	8330	0.075170158	626.167	8330	0.07629771	635.56
	B		15582.84			15816.6			16053.8
NPV	A+B		-29042.2			-28808			-28571
d. therefore from above cal	culations we could see increase	in inflation rate leads to	lesser inflows	and lead to lesser	NPV and vice versa