FIN 486 CART Become Exceptional--fin486cart.com FIN 486 Entire Course | Page 22

< $0), which project would you recommend? Which would you
recommend if the goal were to achieve a higher NPV? P12–6 Impact
of inflation on investments You are interested in an investment
project that costs $40,000 initially. The investment has a 5-year
horizon and promises future end-of-year cash inflows of $12,000,
$12,500, $11,500, $9,000, and $8,500, respectively. Your current
opportunity cost is 6.5% per year. However, the Fed has stated that
inflation may rise by 1.5% or may fall by the same amount over the
next 5 years. LG 2 Assume a direct positive impact of inflation on the
prevailing rates (Fisher effect) and answer the following questions.
(Assume that inflation has an impact on the opportunity cost, but that
the cash flows are contractually fixed and are not affected by
inflation). a.What is the net present value (NPV) of the investment
under the current required rate of return? b.What is the net present
value (NPV) of the investment under a period of rising inflation?
c.What is the net present value (NPV) of the investment under a
period of falling inflation? d.From your answers in a, b, and c, what
relationship do you see emerge between changes in inflation and asset
valuation? P12–17 Real options and the strategic NPV Jenny Rene,
the CFO of Asor Products, Inc., has just completed an evaluation of a
proposed capital expenditure for equipment that would expand the
firm’s manufacturing capacity. Using the traditional NPV
methodology, she found the project unacceptable because LG 6
NPVtraditional = −$1,700 < $0 Before recommending rejection of the
proposed project, she has decided to assess whether there might be
real options embedded in the firm’s cash flows. Her evaluation
uncovered three options: Option 1: Abandonment. The project could
be abandoned at the end of 3 years, resulting in an addition to NPV of
$1,200. Option 2: Growth. If the projected outcomes occurred, an
opportunity to expand the firm’s product offerings further would
become available at the end of 4 years. Exercise of this option is
estimated to add $3,000 to the project’s NPV. Option 3: Timing.
Certain phases of the proposed project could be delayed if market and
competitive conditions caused the firm’s forecast revenues to develop
more slowly than planned. Such a delay in implementation at that
point has an NPV of $10,000. Jenny estimated that there was a 25%
chance that the abandonment option would need to be exercised, a