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 wouThis is just one of many projects for the firm, so any losses 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 adjustment is required. What is the difference in the expected NPV if the inflation adjustment is made vs. if it is not made? Do not round the intermediate calculations and round the final answer to nearest whole number.

WACC	10.0%
Net investment cost (depreciable basis)	$200,000
Units sold	55,000
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%
Anual depreciation rate	4.0%
Tax rate	40.0%

a. $14,051

b. $15,695

c. $18,684

d. $14,947

e. $17,339

Answer 1

NPV without adjustment , Inflation set to 0

	Year 0
Price Per Unit
Variable cost Per unit
Units Sold		55000	55000
Sales Revenues
Less:Fixed Operating Cost
Less Variable Operating Cost
Operating Income
After tax EBIT
Add: Depreciation
Cash inflows

Sales revenues = Unitssold* price per unit

Depreciation = 200000*33.33%

NPV = Present value of cash inflows – Outflows

Present value of cash inflows = Cash inflows/(1+R) ⁿ

=86423 +78566+ 71424 = 236413

= 236,413– 200000 = 36,413

NPV With Inflation set to 4%

Particulars	Year 0	Year1	Year2	Year3
Investment
inflation
Price Per Unit
Variable cost Per unit
Units Sold		55000	55000
Sales Revenues		13,75,000	14,30,000	14,87,200
Less:Fixed Operating Cost
Less Variable Operating Cost		1111000	1,155,550	1,201,750
Less:Depreciation		66,666	66,666	66,666
Operating Income		47334	57,784	68,784
Less:Tax		18,934	23,114	27,514
After tax EBIT		28,400	34670	41,270
Add: Depreciation		66,666	66,666	66,666
Cash inflows		95066	101336	107936

Price per unit in the second year = 25*1.04 = 26

Present Value of Future cash inflows = 86423 +83749 +81093 = 251265

NPV = 251265 – 200000 = 51265

Increase in NPV = 14852

In this problem, the annual depreciation is given twice.so 33.33% is considered as depreciation and 4% is taken as expected inflation rate Moreover, the exact answer is 14852.