When calculating the net present value of an investment project. the firm of Hen

Question

When calculating the net present value of an investment project. the firm of Henry & Norman expects profit in the first year to be dollar 50,000. and they expect real profits to remain at that level over the next five years. Since they are using a nominal discount rate of 10 percent in their net present value calculation, they want to convert future real profits to nominal profits. They expect inflation to be 3 percent per year over the next five years. The nominal profit for year 2 of the investment project is dollar (Enter your response rounded to two decimal places.) If the investment project has an initial cost of $240,000. the net present value in nominal dollars is dollar (Enter your response rounded to two decimal places.) Henry & Norman should not should undertake the investment project.

Explanation / Answer

The formula for Net Present Value (NPV) is:

NPV = CF0 + CF1/(1+r) + CF2/(1+r)2 + ... CFt/(1+r)t

PV of 1 in t years = 1/(1+r)t = discount factor for t years at rate r

PV of CFt in t years = CFt/(1+r)t = CFt + discount factor

They are expecting both real and nominal profits to be $50,000 for year one but they need to calculate NPV for year two i.e. T2, thus we need to discount the $50,000 for a one year.

The nominal profit for year 2 of the investment project is $52, 000

If the initial cost of investment is $240, 000, the net present value in nominal dollars is:

-240000 + 50000/(1+10/100) + 50000/(1+10/100) 2 = 35, 624.89

Thus, Henry & Norman should not undertake the investmnet project.

Related Questions

Navigate

• Browse (All)
• Browse W
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.