Western company is evaluating a capital project that will require a $60,000 initial cash investment and will last 5 years. Net aftertax cash inflows from the project, before adjusting for the effects of inflation, are expected to be as follow:
Year Unadjusted Estimate of Cash Inflows
2................................... $20,000
3................................... 18,000
4................................... 16,000
5................................... 10,000
10,000
No salvage value is expected. The net after-tax cash inflows are expected to increase at the anticipated inflation rate of 10% each year. The company's cost of capital rate is 15%. (The 15% is a nominal rate. This exercise demonstrates the size of the error involved when a nominal discount rate is used with unadjusted cash flows.)
Required:
(1) Compute the estimated cash inflow for each year, adjusted for the anticipated effects of inflation.
(2) Determine the net present value of the cash flows before and-after the inflation adjustment. Use the 15% nominal discount rate for both calculations.