Analyzing an average-risk project

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Reference no: EM132044671

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 will have a salvage value that will be subject to inflation. This is just one of many projects for the firm, so any losses 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 adjustment is required. What is the difference in the expected NPV if the inflation adjustment is made vs. if it is not made?

WACC 10.0%

Net investment cost (depreciable basis) $105,000

Salvage at end of project (without inflation) $10,000

Units sold 50,000

Average price per unit, during Year 1 $12.50

Fixed op. cost excl. deprec. (constant) $75,000

Variable op. cost/unit, during Year 1 $10.00

Annual depreciation rate 33.333%

Expected inflation starting year 2: 3.00%

Tax rate 25.0%

Reference no: EM132044671

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