A three-year financial project is forecast to have net cash inflows of $40,000lf

Question

A three-year financial project is forecast to have net cash inflows of $40,000lfor its duration. It will cost $90,000 to implement the project, $45,000 of which payable at the beginning of the project, and the remainder equally payable at the end of each year of the project. If the required rate of return is 15%, conduct a discounted cash flow calculation to determine the NPV. What would happen to the NPV of the above project if you compute the expected yearly inflation to be 10% percent for the next 5 years? a) b)

Explanation / Answer

Transaction on base year = -45000

Transaction in first year = 40000

Transaction in second year = 40000

Transaction in third year = 40000

1) NPV using discounted cash flow = -45000 + 40000/(1+0.15) + 40000/(1+0.15)^2 + 40000/(1+0.15)^3 = 46329

2)NPV using discounted cash flow and inflation = -45000 + 40000*(1+0.1)/(1+0.15) + 40000*(1+0.1)^2/(1+0.15)^2 + 40000*(1+0.1)^3/(1+0.15)^3 = 64864.39

The NPV increases when the inflation factor is taken into consideration.

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