Berg Company wants to buy a new machine to be used in production that will replace an existing manual system. The outlay required is $7,000,000. The equipment will last five years with no expected salvage value. The expected incremental after-tax cash flows (cash flows of the equipment less cash flows of the old equipment) associated with the project follow:

Berg has a cost of capital equal to 10 percent. The above cash flows are expressed without any consideration of inflation.
Required:
1. Compute the payback period.
2. Calculate the NPV and IRR of the proposed project.
3. Inflation is expected to be 5 percent per year for the next five years. The discount rate of 10 percent is composed of two elements: the real rate and the inflationary element. Since the discount rate has an inflationary component, the projected cash flows should also be adjusted to account for inflation. Make this adjustment, and recalculate the NPV. Comment on the importance of adjusting cash flows for inflationary effects.

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Cash Benefits Cash Expenses Year $7,800,000 $6,000,000 7,800,000 6,000,000 6,000,000 6,000,000 4 7,800,000 7,800,000