Question

A project costs $12,800 and is expected to provide a real cash inflow of $10,000 at the end of each of years 1 through 5. Calculate the net present value of this project if inflation is expected to be 4% in each year and the firm employs a nominal discount rate of 10%.

Answer #1

NPV = Present value of cash inflow (PVCI) - Present Value of cash outflow (PVCO)

PVCO = $ 12,800

PVCI

Nominal cash flow = Real cash flow * ( 1 + inflation rate )

Year | Real cash flow | Nominal cash flow | Present value |

1 | 10,000 |
10,000 * 1.04 = 10,400 |
= 10,400 / 1.10 = 9,454.55 |

2 | 10,000 |
10,000 * 1.04 = 10,816 |
= 10816/1.1 = 8938.84 |

3 | 10,000 |
10,000 * 1.04 = 11,248.64 |
= 11,248.64 / 1.10 = 8451.27 |

4 | 10,000 |
10,000 * 1.04 = 11698.59 |
= 11698.59 / 1.10 = 7990.29 |

5 | 10,000 |
10,000 * 1.04 = 12166.53 |
= 12166.53 / 1.10 = 7554.46 |

PVCI | 42389.41 |

NPV = 42389.41 - 12,800

= **$ 29,586.41
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