Question

8) A project costs $1200 immediately. The project yields nominal returns of $200 in years 1 and 2, $250 in years 3 and 4, and $300 in year 5. In addition, the project will have capital worth $400 leftover at the end of year 5. The real discount rate is 4% and the expected inflation rate is 2%. What is the NPV of this project?

Answer 1

Nominal return means the return without adjusting the inflation effect
So in the present case first we have to find out the real return after that discounted retrun to find out present value
Year	0	1	2	3	4	5	NPV
Capital outflow	-1,200
Salvage Value						400
Annual Inflow		200	200	250	250	300
Free Cash Flow	-1,200	200	200	250	250	700
Inflation factor=1/(1+2%)^n	1.00000	0.98039	0.96117	0.94232	0.92385	0.90573
Real Free Cash Flow	-1,200.00	196.08	192.23	235.58	230.96	634.01
Disc. Factor=1/(1+4%)^n	1.000000	0.961538	0.924556	0.888996	0.854804	0.821927
Disc. Free Cash flow	-1,200.00	188.54	177.73	209.43	197.43	521.11	94.24
NPV of the project is $94.24