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 $554176. They will increase by 4% per year in real terms. The only annual cost will be to lease the whole operation for $118845 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 into perpetuity.

What is the NPV of the project?

Select one:

a. $6921840

b. $8029703

c. $9139137

d. $8940472

e. $8267772

Answer 1

Increase n revenue in Nominal terms

I.e Growth of revenue in nominal terms

Nominal rate = (1+RR)(1+IR) - 1

= (1+0.04)(1+0.05) - 1

= (1.04)(1.05) -1

= 1.092 - 1

0.092

Nominal Discount rate

Nominal rate = (1+RR)(1+IR) - 1

= (1+0.10)(1+0.05) - 1

= (1.10)(1.05) -1

= 1.155 - 1

0.155

15.5%

NPV = PV of Revenues - PV of Costs

PV of Revenues = Revenue1 / (Req Ret - Growth)

= $ 554176 / ( 0.155 - 0.092)

= $ 554176 / 0.063

= $ 8796444

PV of Cost = COst / (Req Ret)

= $ 118845 / 0.155

= $ 766742

NPV = PV of Revenues - PV of Costs

= $ 8796444 - $ 766742

= $ 8029703

Option b is correct.