Reference no: EM132419168

Question 1: Adam is thinking of leaving his current job on 12/31/X0 in order to set up a mushroom farm which he intends to run for 5 years. The land needed for the project can be purchased on 12/31/X0 for $500,000 (nominal) and it is expected it can be sold on 12/31/X5 for $500,000 (real). The land cannot be depreciated; gains and losses on the land are not subject to taxation. The equipment needed can be purchased on 12/31/X0 for $150,000 (nominal). It has an expected life of five years and its salvage value is expected to be $25,000 (real). The equipment is depreciated on a straight line basis. The output of the farm is expected to be 0.85 tons of mushrooms per year. The price of mushrooms on 12/31/X0 is expected to be $200,000 per ton (nominal) and is expected to grow at 4 percent in real terms. The total annual costs at 12/31/X0 prices are $50,000 (nominal) and are expected to increase at 8 percent in real terms. The total working capital needs are expected to remain constant at $100,000 (nominal) throughout the five years. The working capital is recovered at the end of the project. The rate of inflation over the next five years is expected to be 5 percent. The nominal discount rate for this type of project is 10 percent. The tax rate for the farm is 34 percent. Assume all cash flows occur at the end of the year and all losses can be offset against other income.

Question 2: What is the NPV of the project on 12/31/X0? Show your calculations in both real and nominal terms.