If an investment costing $2,000 is expected to generate real cash flows of $900 p.a. for three years, prices are expected to increase at a rate of 5% p.a., and the nominal cost of capital is 15%, what is the net present value of the investment?

Answer rating: 100% (QA)

To calculate the net present value NPV of the investment you need to discount the expected cash flows to their present values and then subtract the initial cost of the investment In this case you are dealing with real cash flows but you have the nominal cost of capital and an expected inflation rate To get real discount rates you need to adjust for inflation Here are the steps to calculate the NPV Calculate the real discount rate rreal using the nominal cost of capital rnominal and the expected inflation rate i rreal 1 rnominal 1 i 1 rreal 1 015 1 005 1 rreal 115 105 1 rreal 10952 1 rreal 00952 or 952 Calculate the present value PV of each cash flow ... View the full answer