Question

A company has the project costs $50,000 now and $6000 per year for 7 years beginning 1 year from now with increases of 8% per year thereafter for the next 9 years. Calculate a project’s present worth with a real interest rate of 10% per year and an inflation rate of 4% per year.

Answer 1

Project cost = $ 50,000

Annual cash flow = $ 6,000 (first 7 years)

After 7th year it increases at a rate of 8% for next 9 years.

Real rate = 10%

Calculating the PW using real rate of return

The present worth of the project at real interest rate = - $ 104,520.25

Now, calculating the PW at nominal rate

Inflation rate = 4%

Nominal rate = (1+0.1)(1+0.04) -1 = 0.144

Nominal rate = 14.4%

Calculating PW at the nominal rate

I have determined the present worth of the project using real rate as well as nominal interest rate.

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