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) $199,500 Units sold 50,000 Average price per unit, Year 1 $28.00 Fixed op. cost excl. depr. (constant) $154,000 Variable op. cost/unit, Year 1 $21.30 Annual depreciation rate 33.333% Expected inflation 4.00% Tax rate 40.0% ​

a.	$18,967
b.	$15,364
c.	$15,933
d.	$19,157
e.	$20,674

Answer 1

answer A $18,967

Cost of machine	199500					Cost of machine	199500
Salvage Value	0					Salvage Value	0
Life of machine	3					Life of machine	3
Annual depreciation	66500					Annual depreciation	66500
Compute net present value considering 4% inflation as follows:		Compute net present value without effect of inflation as follows:
Year	0	1	2	3		Year	0	1	2	3
Unit Sales		50000	50000	50000		Unit Sales		50000	50000	50000
inflation Rate		0.04	0.04	0.04		Selling Price per unit		28	28	28
Selling Price per unit		28	29.12	30.28		Marginal Cost per unit		21.3	21.3	21.3
Marginal Cost per unit		21.3	22.15	23.04		Sales Revenue ( Units Sold *Selling Price )		1400000	1400000	1400000
Sales Revenue ( Units Sold *Selling Price )		1400000	1456000	1514240		Total Marginal cost ( Units Sold *variable cost )		1065000	1065000	1065000
Total Marginal cost ( Units Sold *variable cost )		1065000	1107600	1151904		Depreciation		66500	66500	66500
Depreciation		66500	66500	66500		Fixed Cost		154000	154000	154000
Fixed Cost		154000	154000	154000		Income before tax		181000	181000	181000
Income before tax		181000	194400	208336		Less: Taxes		72400	72400	72400
Less: Taxes		72400	77760	83334.4		Income after taxes		108600	108600	108600
Income after taxes		108600	116640	125001.6		Add: Depreciation		66500	66500	66500
Add: Depreciation		66500	66500	66500		Gross operating Cash flow		175100	175100	175100
Gross operating Cash flow		175100	183140	191501.6		Capital Spending machinery	-199500	0	0	0
Capital Spending machinery	-199500	0	0	0		Net operating Cash flow	-199500	175100	175100	175100
Net operating Cash flow	-199500	175100	183140	191501.6		present Value factor @ 10%	1	0.909091	0.826446	0.751315
present Value factor @ 10%	1	0.909091	0.826446	0.751315		Present value of cash flow	-199500	159181.8	144710.7	131555.2
Present value of cash flow	-199500	159181.8	151355.4	143878		Net present value	235947.8
Net present value	254915.2
Difference in net present value	18967.39