Question

swf is considering a project that is expected to generate real cash flows of $10 million at the end of each year for 5 years. the intial outlay/investment required is $25 million. a nominal discount rate of 9.2% is appropriate for the risk level. inflation is 5% 1. you are company's financial analyst. the CFO has asked you to calculate the NPV using a schedule of future nominal cash flows. 2. justify the NPV will remain the same while rearranging for inflation and real cash flows calculations.

Answer 1

NPV using Nominal Cash Flows				NPV using Real Cash Flows
Years	Real Cash Flows	Nominal CF	PVF @9.25%	Amount		Years	Real Cash Flows	PVF @4.05%	Amount
	A	B=A*(1+Inf)^N	C	B*C			A	C	B*C
Year 0	-25	-25	1.000	-25.00		Year 0	-25	1.000	-25.00
Year 1	10	11	0.915	9.61		Year 1	10	0.961	9.61
Year 2	10	11	0.838	9.24		Year 2	10	0.924	9.24
Year 3	10	12	0.767	8.88		Year 3	10	0.888	8.88
Year 4	10	12	0.702	8.53		Year 4	10	0.853	8.53
Year 5	10	13	0.643	8.20		Year 5	10	0.820	8.20
	NPV			19.46			NPV		19.46

Real Discount Factor = (1+Nominal Discount Factor) / (1+ Inflation) -1

=(1.0925)/(1.05) -1 => 4.05%

NPV is same in both analysis using either type of cash flows.

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