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Inflation adjustment:
A project requires an initial investment of $8,000, has a 4-year life and provides expected cash flows as follows, based on year 1 prices and costs:
annual revenue = $5,000
annual cash operating costs = $2,000
annual depreciation = $2,000
terminal cash flow = 0
cost of capital = 14%
T = 30%
Question a. Calculate the annual operating cash flows without adjusting for inflation. (Are these cash flows real or nominal?) Calculate the associated NPV.
Question b. Adjust the cash flows to reflect the effects of inflation, which is expected to affect sales revenue and cash operating expenses at the rate of 4% annually. (Are these cash flows real or nominal?) Calculate the associated NPV.
Question c. Which NPV is the correct one for evaluating the project?
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