The present $ cash flow distribution associated with a five-year project is show

Question

The present $ cash flow distribution associated with a five-year project is shown below. Assuming that an inflation rate of 6% per annum is expected over the next eight years, and using minimal accepted rate of return of 15% when appropriate, determine the following: The project's Present value ratio. [2.12yrs] The project's Payback period. [2.5 yrs] Instead of assuming a constant annual inflation rate of 6% as described above, suppose that the inflation rate is expected to vary as indicated below. Determine the project's net present value under these conditions. [$12.25 times 10^6]

Explanation / Answer

Real discount rate
= (1 + nominal discount rate) ÷ (1+inflation rate) – 1
nominal discount rate – inflation rate
= (1+ 15%) ÷ (1+6%) – 1
= 8.49%

yesr Cash flows Nominal cash flow at 6% inflation PV at discount rate 15% Cumlative cash flow 0 -10              (10.00)      (10.00) 1 4                   4.24           3.69                                  3.69 2 4.5                   5.06           3.82                                  7.51 remaining balance after 2 years value for 3rd year Payback period 3 5                   5.96           3.92                                11.43                                                          2.49                            0.64                        2.64 4 5.5                   6.94           3.97 5 6.5                   8.70           4.32         19.72 yesr Cash flows Inflation rate Nominal cash flow PV at discount rate 15% 0 -10      (10.00)                             (10.00) 1 4 2%           4.08                                  3.55 2 4.5 4%           4.87                                  3.68 3 5 4%           5.62                                  3.70 4 5.5 6%           6.94                                  3.97 5 6.5 6%           8.70                                  4.32 NPV                                  9.22

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