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NPV with Inflation for Clarkwood Wood Products

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Clarkwood is a British Columbia wood products manufacturer. They are considering a modification to their production line that would enable an increase in their output. One of Clarkwood's concerns is that the price of wood is rising more rapidly than inflation. They expect that because of this their operating cost per unit will rise at a rate 4% higher than the rate of inflation. That is, if the rate of inflation is f, Clarkwood's operating cost will rise at the rate f_c = 1.04(1 + f) - 1. However, competitive pressures from plastics will prevent the prices of their products from rising more than 1% above the inflation rate. The particulars of the project are shown in the table below.

Clarkwood's Project
Output price in 2006 ($/unit) 30
Price increase %2 above inflation
Operating cost in 2006 ($/unit) 24
Operating cost increase %4 above inflation
Expected output due to project (units/year) 50,000
First cost in 2005 ($)
Observed actual dollar MARR 0.25
Time horizon (years) 10

a) Find the present worth of the project under the assumption of zero inflation.

b) Find the present worth of the project under these assumptions: the expected inflation is (i) 1% per year, and (ii) 2% per year.

c) Should Clarkwood accept the project?

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This solution provides calculations for NPV under inflation in an attached Excel file.

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