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