Question

Vivant Solar is considering another project. The project has initial investment cost of $18 million and will return $7.75 million a year in real terms over the next 3 years. Because of changing economic conditions, you expect inflation to be 5% for all years after the first payment in T1. The nominal project discount rate applicable for all periods is 9%. Draw a time line of project cash flows and calculate the nominal NPV of the project.

Answer 1

year	t=0	t=1	t=2	t=3
nominal cash flows	-18	8.14	8.54	8.97

First we need to find out the nominal values for 3 years as nominal cash flows can be discounted by nominal discount rate

Years	Real cash flows	Nominal cash flows ( realcashflows * ( 1 + inflation)^no of years )	Discounting factor = 1 /( 1+r)^n	Present value
1	7.75	8.1375	0.917431193	7.46559633
2	7.75	8.544375	0.841679993	7.191629492
3	7.75	8.97159375	0.77218348	6.927716484
Sum of present values	21.58494231
Less : Initial Investment	18
NPV	3.584942306