Question

In: Finance

The following information is available about an investment opportunity. Investment will occur at year 0 and...

The following information is available about an investment opportunity. Investment will occur at year 0 and sales will occur from year 1 to year 8. Use a nominal discount rate, calculated as in = (1 + ir)(1 + p) – 1, where ir is the real discount rate, and p is expected inflation.

Facts and assumptions

Initial cost $28,000,000

Unit sales $400,000

Selling price per unit, year 1 $60

Variable cost per unit, year 1 $42

Life expectancy (years) 8

Salvage value $0

Depreciation Straight-line

Tax rate 37%

Real discount rate 10.0%

Inflation rate 0.0%

a. Prepare a spreadsheet to estimate the project’s annual after-tax cash flows.

b. Calculate the investment’s internal rate of return and its net present value assuming zero inflation.

c.

How do the internal rate of return and net present value change when you assume an inflation rate of 8 percent per year in price and variable cost per unit?

d. How do you explain the fact that inflation causes the internal rate of return to increase and the NPV to decrease?

e. Does inflation make this investment more attractive or less attractive? Why?

Solutions

Expert Solution

Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8
Sales $ 2,40,00,000 2,40,00,000 2,40,00,000 2,40,00,000 2,40,00,000 2,40,00,000 2,40,00,000 2,40,00,000
Varialble Cost $ 1,68,00,000 1,68,00,000 1,68,00,000 1,68,00,000 1,68,00,000 1,68,00,000 1,68,00,000 1,68,00,000
EBITDA $ 72,00,000 72,00,000 72,00,000 72,00,000 72,00,000 72,00,000 72,00,000 72,00,000
Depreciation $ 35,00,000 35,00,000 35,00,000 35,00,000 35,00,000 35,00,000 35,00,000 35,00,000
EBT $ 37,00,000 37,00,000 37,00,000 37,00,000 37,00,000 37,00,000 37,00,000 37,00,000
Tax $ 13,69,000.0 13,69,000.0 13,69,000.0 13,69,000.0 13,69,000.0 13,69,000.0 13,69,000.0 13,69,000.0
Net Income $ 23,31,000 23,31,000 23,31,000 23,31,000 23,31,000 23,31,000 23,31,000 23,31,000
a. Cash Flow Statement
Sales $ 2,40,00,000 2,40,00,000 2,40,00,000 2,40,00,000 2,40,00,000 2,40,00,000 2,40,00,000 2,40,00,000
Varialble Cost $ 1,68,00,000 1,68,00,000 1,68,00,000 1,68,00,000 1,68,00,000 1,68,00,000 1,68,00,000 1,68,00,000
Capex $ 2,80,00,000
Tax 13,69,000.0 13,69,000.0 13,69,000.0 13,69,000.0 13,69,000.0 13,69,000.0 13,69,000.0 13,69,000.0
Cash $ (2,80,00,000.0) 58,31,000.0 58,31,000.0 58,31,000.0 58,31,000.0 58,31,000.0 58,31,000.0 58,31,000.0     58,31,000.0

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