4. Inflation adjustments, A project requires an initial investment of $8,000, has a 4-year life and provides expected cash flows as follows, based on year 1 prices and costs:

 

annual revenue = $5,000

annual cash operating costs = $2,000

annual depreciation = $2,000

terminal cash flow = 0

cost of capital = 14%

T = 30%

a. Calculate the annual operating cash flows without adjusting for inflation. (Are these cash flows real or nominal?) Calculate the associated NPV.

b. Adjust the cash flows to reflect the effects of inflation, which is expected to affect sales revenue and cash operating expenses at the rate of 4% annually. (Are these cash flows real or nominal?) Calculate the associated NPV.

c. Which NPV is the correct one for evaluating the project?

Q:5A company is considering a project that requires an initial investment of $24M to build a new plant and purchase equipment.The investment will be depreciated as a MACRS 7-year class asset.The new plant will be built on some of the company's land which has a current, after-tax market value of $4.3M.The company will produce units at a cost of $130 each and will sell them for $420 each.There are annual fixed costs of $0.5M.Unit sales are expected to be 150,000 each year for the next 6 years, at which time the project will be abandoned.At that time, the plant and equipment is expected to be worth $8M (before tax) and the land is expected to be worth $5.4M (after tax).To supplement the production process, the company will need to purchase $1M worth of inventory.That inventory will be depleted during the final year of the project. Cost of capital is 15%.The company's marginal tax rate is 40%.Should the project be accepted?