Inflation Adjustments The Rodriguez Company is considering an average-risk inves
ID: 2766283 • Letter: I
Question
Inflation Adjustments
The Rodriguez Company is considering an average-risk investment in a mineral water spring project that has a cost of $130,000. The project will produce 800 cases of mineral water per year indefinitely. The current sales price is $143 per case, and the current cost per case is $110. The firm is taxed at a rate of 36%. Both prices and costs are expected to rise at a rate of 7% per year. The firm uses only equity, and it has a cost of capital of 14%. Assume that cash flows consist only of after-tax profits, since the spring has an indefinite life and will not be depreciated.
a. What is the NPV of the project? Do not round intermediate steps. Round your answer to the nearest hundred dollars. (Hint: The project is a growing perpetuity, so you must use the constant growth formula to find its NPV.)
Explanation / Answer
Profit is calculated as ,
Sales 143
Less Cost 110
Profit before tax. $ 33
Lesd tax @ 36% $11.88
Profit after tax $21.12
Total profit 21.12 × 800 units = $16896
Inflows in CASe of perpetuity are =
profit ( 1+ growth) / ke - g , ke = cost of equity
= 16896(1 + .07) /14 - 7 %
$ 258367
Npv = cash inflows - cash outflows
= $258367 - $130000
= $128367