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, it will be depreciated on a straight-line basis, and there will be no salvage value. No change in net operating working capital would be required. 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%
Net investment cost (depreciable basis) $200,000
Units sold            38,000
Average price per unit, Year 1     $25.00
Fixed op. cost excl. depr. (constant)          $150,000
Variable op. cost/unit, Year 1      $20.20
Annual depreciation rate              33.333%
Expected inflation            4.00%
Tax rate               40.0%

Answer 1

Soln : First we will calculate without using any infation adjustment here, please refer table where cash flows are metioned:

Year	0	1	2	3
Net Investment cost	-200000.00
Revenue = units sold* price per unit		950000.00	950000.00	950000.00
Fixed op. cost		-150000	-150000	-150000
Variable cost		-767600	-767600	-767600
Annual dep.		-66660	-66660	-66660
Net Value		-34260.00	-34260.00	-34260.00
discount rate =1/1.1^t		0.9091	0.8264	0.7513
PV		-31145.45	-28314.05	-25740.05
NPV	-85199.55

Now, we calculate with inflation rate, please note WACC can be used in nominal rate

Year	0	1	2	3
Net Investment cost	-200000.00
Revenue = units sold* price per unit		950000.00	988000.00	1027520.00
Fixed op. cost		-150000	-150000	-150000
Variable cost		-767600	-798304	-830236.16
Annual dep.		-66660	-66660	-66660
Net Value		-34260.00	-26964.00	-19376.16
discount rate =1/1.1^t		0.9091	0.8264	0.7513
PV		-31145.45	-22284.30	-14557.60
NPV	-67987.35

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