An investment of $254,200 in special tools, with a life expectancy of four years and a residual price of $24,000, is being examined at December 31, 2012 by StrengthCo. The tools will enable StrengthCo to manufacture drill bits to very high tolerances without incurring any incremental costs, and to earn additional cash flows of $2.40 per unit in 2013, $2.54 in 2014, $2.70 in 2015, and $2.86 in 2016. StrengthCo expects to sell 37,500 units each year for the next four years. StrengthCo is subject to a 40% tax rate.
The after-tax required rate of return determined by the plant manager, James Marco, is 18%.
The tools qualify for a capital cost allowance rate of 35%, declining balance.
REQUIRED
1. Compute the net present value of the project.
2. Marco feels that inflation will persist for the next four years at the rate of 6% per year. However, the 18% minimum desired rate of return already includes a return required to cover the effects of anticipated inflation. Repeat requirement 1 to take inflationary effects into consideration.
3. Could you have taken inflation into account in a way different from what you did in requirement 2? Broadly describe how without actually performing any calculations.