Question

Poulsen Industries is analyzing an average-risk project, and the following data have been developed. Unit sales will be constant, but the sales price should increase with inflation. Fixed costs will also be constant, but variable costs should rise with inflation. The project should last for 3 years. Under the new tax law, the equipment for the project is eligible for 100% bonus depreciation, so it will be fully depreciated at t = 0. At the end of the project’s life, the equipment will have no salvage value. No change in net operating working capital (NOWC) would be required for the project. This is just one of many projects for the firm, so any losses on this project can be used to offset gains on other firm projects. The marketing manager does not think it is necessary to adjust for inflation since both the sales price and the variable costs will rise at the same rate, but the CFO thinks an inflation adjustment is required. What is the difference in the expected NPV if the inflation adjustment is made versus if it is not made? Do not round the intermediate calculations and round the final answer to the nearest whole number.

WACC	10.0%
Equipment cost	$200,000
Units sold	54,000
Average price per unit, Year 1	$25.00
Fixed op. cost	$150,000
Variable op. cost/unit, Year 1	$20.20
Expected annual inflation rate	4.00%
Tax rate	25.0%

a. $18,345

b. $16,437

c. $13,648

d. $12,621

e. $15,409

Answer 1

		NO INFLATION		WITH INFLATION
REVENUES	54000*25	1350000	54000*25	13500000	1404000*	1460160*
VARIABLE COSTS	54000*20.20	1090800	54000*20.20	1090800	1134432	1179809.28
FIXED COSTS		150000		150000	150000	150000
DEPRECIATION		0.00		0.00	0.00	0.00
EBT		109200		109200	119568	130350.72
TAX	25%	27300		27300	29892	32587.68
NET INCOME		81900		81900	89676	97763.04
DEPRECIATION		0.00		0.00	0.00	0.00
NET CASH FLOW		81900		81900	89676	97763.04
PVIFA@10% 3 YEARS [FORMULA=[1/r*(1-[1/1+r)*n]]		2.486852		0.909091	0.826446	0.751315
PV OF ALL CASH FLOW		203673.18		74454.55	74112.40	73450.82
NET INVESTMENT		-150000
NPV=		53673.18

working note

*1350000*[1+(1.04)] =1404000

*1404000*[1+(1.04)] = 1460160

*1090800*[1+(1.04)] = 1134432

*1134432*[1+(1.04)] = 1179809.28

.

PV of all cash flow

No.inflation = 53673.18

With inflation = 74454.55 + 74112.40 + 73450.82 = 72017.76

CHANGE IN NPV = 72017.76-53673.18 = 18345