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 $493649. They will increase by 4% per year in real terms. The only annual cost will be to lease the whole operation for $181856 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. $7701740

b. $5675563

c. $7026512

d. $7650709

e. $6662434

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)

= $ 493649 / ( 0.155 - 0.092)

= $ 493649 / 0.063

= $ 7835698

PV of Cost = COst / (Req Ret)

= $ 181856 / 0.155

= $ 1173265

NPV = PV of Revenues - PV of Costs

= $ 7835698 - $ 1173265

= $ 6662434

Option e is correct.