Question

msider the following project's after-tax cash flow and the expected annual general inflation rate during the project period. General Inflation Rate O Expected Cash Flow End of Year EX (in Actual $) - $40,000 $27,000 $27,000 $27,000 3.3% 4.1 WN 5.1 (a) Determine the average annual general inflation rate over the project period. The average annual general inflation rate is 1%. (Round to two decimal places.) (b) Convert the cash flows in actual dollars into equivalent constant dollars with the base year 0. The equivalent cash flow in constant dollars at the end of year is $ (Round to the nearest dollar.) The equivalent cash flow in constant dollars at the end of year 1 is $ . (Round to the nearest dollar.) The equivalent cash flow in constant dollars at the end of year 2 is $ . (Round to the nearest dollar) The equivalent cash flow in constant dollars at the end of year 3 is $ (Round to the nearest dollar) Click to select your answer(s).

Answer 1

a) Average annual inflation rate = (3.3 +4.1+5.1)/3

= 12.5 /3

= 4.17%

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b)  Constant Dollar Value in a given year = (Previous year dollar value × CPI in the given year)/ CPI in the base year

• cash flow in constant dollar at the end of year 0 = -40000*(100/100) =-40,000
• cash flow in constant dollar at the end of year 1 = 27000*(103.3/100) = 27,891
• cash flow in constant dollar at the end of year 2 = 27000*(104.1/100) = 28,107
• cash flow in constant dollar at the end of year 3 = 27000*(105.1/100) = 28,377

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c) if the nominal interest rate is 9%

Present woth of the cash flowis

= 27000/(1.09) + 27000/(1.09)^2 + 27000(1.09)^3

= 24684+22567+20632

= 67,883

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Yes the project is acceptable as the Present value of our cash flow from the investment is $67,883 while we have invested only $40,000 so we make a profit of $ 27,883