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 * 1.042 = 10,816	= 10816/1.12 = 8938.84
3	10,000	10,000 * 1.043 = 11,248.64	= 11,248.64 / 1.103 = 8451.27
4	10,000	10,000 * 1.044 = 11698.59	= 11698.59 / 1.104 = 7990.29
5	10,000	10,000 * 1.045 = 12166.53	= 12166.53 / 1.105 = 7554.46
		PVCI	42389.41

NPV = 42389.41 - 12,800

       = $ 29,586.41 Answer