Desai 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 there will be no salvage value. This is just one of many projects for the firm, so any losses can be used to offset gains on other firm projects. What is the project's expected NPV?
Net investment cost (depreciable basis) $200,000
Units sold 48,000
Average price per unit, Year 1 $25.00
Fixed op. cost excl. depr. (constant) $150,000
Variable op. cost/unit, Year 1 $20.20
Annual depreciation rate 33.333%
Expected inflation rate per year 5.00%
Tax rate 40.0%
This solution illustrates how to compute the net present value of a project with cash flows which change with the inflation rate.