A soft drink bottler is trying to determine the present value of its business in an area where it forecasts no growth in unit sales. Sales this year will be $10 million and expenses will be $9 million. The present rate of return required is 20 percent, and inflation is expected to be 10 percent indefinitely.
The company president believes that the present value of the business is $5 million, that is, $1 million per year discounted at 20 percent. His assistant argues that the present value is $1 million divided by 10 percent, the expected real interest rate. This yields an NPV of $10 million. What is the correct solution to the valuation problem?