Question

You are assessing the viability of operating an amusement park. The nominal revenues from ticket sales at the end of Year 1 will be $632372. They will increase by 4% per year in real terms. The only annual cost will be to lease the whole operation for $159902 per year. The leasing costs are nominal and will start at the end of Year 1. They will stay fixed in nominal terms. Assume the inflation rate is 5% and the real discount rate is 10%. All cash flows occur at year-end. The company will not pay any taxes. The business will continue in perpetuity. What is the NPV of the project?

Select one:

a. $9006025

b. $9326271

c. $10118181

d. $10272008

e. $7741837

Answer 1

Final answer

Select Option - a............. $9,006,025

Explanation

When we have Inflation of 5%, the discount rate in nominal terms is defined as under

( 1 + real rate ) * (1 + inflation rate ) - 1 = (1.10) * (1.05) - 1 = 0.155

Similarly the growth rate in nominal terms = ( 1.04) * (1.05) - 1 = 0.092

Value of a perpetuity = Perpetual amount / ( Discount rate - growth rate)

Now value of sales revenue = 632372 / ( 0.155 - 0.092) = 10037650.79

Now value of annual cost = 159902 / 0.155 = 1031625.81

Here .......... growth rate is "0"

Finally the NPV = Value of sales revenue - Value of annual cost = 10037650.79 - 1031625.81 = 9,006,025