Question

c) What is the impact of inflation on Project Appraisal and how can companies address these issues.

Required ( 200 words )

Answer 1

Forecasts of expenditure and in-payments have to be made, and we have to consider the increase of prices for inputs and make assumptions about the increase of output prices. Furthermore, we have to consider the need to increase several components of the working capital, inclusive of often neglected items such as cash in hand. Since we should make a calculation of the profitability of a project after tax, we have also to follow the standard procedures of accountants. However, this is now not ex post, but to prepare forecast income statements, and, if necessary, projected balance sheets. Last and not least, the net cash flow after tax for the project, as well as the net cash return on equity, has to be derived.

1. Discuss the apparent reasons why the real prices approach persists in investment appraisal.

2.Review briefly some of the main impacts of inflation and use simple numerical examples to illustrate the ideas.

3. Conduct a simple sensitivity analysis of the NPV of the project with the expected inflation rate.

*First, we conduct a simple sensitivity analysis of the NPV of the project with the expected inflation rate.

* Conduct a detailed sensitivity analysis of the PV of each line item in the FCF statement and identify the specific effects of inflation. Explain the reasons for the inadequacy of the real prices method

4.Redo the analysis with different scenarios for the expected inflation rates.

Information on the project appraisal influences the company on the present value and the company should make necessary steps to eradicate them