Consider the following cash flows on two mutually exclusive projects: The cash f

Question

Consider the following cash flows on two mutually exclusive projects:

The cash flows of Project A are expressed in real terms, whereas those of Project B are expressed in nominal terms. The appropriate nominal discount rate is 11 percent and the inflation rate is 5 percent.

Calculate the NPV for each project. (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)

46,000  

Year Project A Project B 0 –$ 55,000 –$ 70,000 1 35,000 34,000 2 30,000 43,000 3 25,000

46,000  

Explanation / Answer

Real rate=1.11/1.05-1=5.71%

Project A has real cash flows, so we will use real discount rate

NPV of A=-55000+35000/1.057^1+30000/1.057^2+25000/1.057^3=26133.97

we might have used 6% rate as real using approximation method, the NPV OF A will be=

=-55000+35000/1.06^1+30000/1.06^2+25000/1.06^3=25709.24

now when we have B as nominal cash, we will use nominal rate

NPV of B=-70000+34000/1.11^1+43000/1.11^2+46000/1.11^3=29165.20

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