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 excl. depr. (constant) $150,000 Variable op. cost/unit, Year 1 $20.20 Expected annual inflation rate 4.0% Tax rate 25.0% Group of answer choices $12,621 $13,648 $15,409 $16,437 $18,345

Answer 1

Net present value of cash inflows without considering inflation
Particulars	Year 1	Year 2	Year 3
Sales volume (units) (A)	54,000	54,000	54,000
Average price per unit	25.0	25.0	25.0
Variable cost per unit	20.2	20.2	20.2
Contribution p.u. (Selling price- Variable cost) (B)	4.8	4.8	4.8
Total contribution (A)*(B)	259,200	259,200	259,200
Fixed costs	(150,000)	(150,000)	(150,000)
Depreciation	(200,000)	-	-
Operating cash flows before tax	(90,800)	109,200	109,200
Tax @ 25%	22,700	(27,300)	(27,300)
Operating cash flows after tax (C)	(68,100)	81,900	81,900
Add : Depreciation (D)	200,000	-	-
Total Operating cash inflows (C)+(D)	131,900	81,900	81,900
PVF @ 10%	0.909	0.826	0.751
Present value of cash inflows	119,909	67,686	61,533
Total present value of cash inflows	249,128
Less: Cash outflows at Year 0	(200,000)
Net present value	49,128

Net present value of cash inflows considering inflation
Particulars	Year 1	Year 2	Year 3
Sales volume (units) (A)	54,000	54,000	54,000
Average price per unit	25.00	26.00	27.04
Variable cost per unit	20.2	21.01	21.85
Contribution p.u. (Selling price- Variable cost) (B)	4.8	5.0	5.2
Total contribution (A)*(B)	259,200	269,568	280,351
Fixed costs	(150,000)	(150,000)	(150,000)
Depreciation	(200,000)	-	-
Operating cash flows before tax	(90,800)	119,568	130,351
Tax @ 25%	22,700	(29,892)	(32,588)
Operating cash flows after tax (C)	(68,100)	89,676	97,763
Add : Depreciation (D)	200,000	-	-
Total Operating cash inflows (C)+(D)	131,900	89,676	97,763
PVF @ 10%	0.909	0.826	0.751
Present value of cash inflows	119,909	74,112	73,451
Total present value of cash inflows	267,472
Less: Cash outflows at Year 0	(200,000)
Net present value	67,472

Difference in expected NPV = NPV with inflation - NPV without inflation

= $67,472 - $49,128

= $18,345