Inflation Adjustments The Rodriguez Company is considering an average-risk inves
ID: 2766367 • 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 $170,000. The project will produce 850 cases of mineral water per year indefinitely. The current sales price is $142 per case, and the current cost per case is $106. The firm is taxed at a rate of 36%. Both prices and costs are expected to rise at a rate of 6% per year. The firm uses only equity, and it has a cost of capital of 12%. Assume that cash flows consist only of after-tax profits, since the spring has an indefinite life and will not be depreciated.
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.)
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Explanation / Answer
Initial Capital = $170,000
Number of Cases of Mineral Water = 850
Sale Price Year 1 = $142
Cost Price Year 1 = $106
Cost Of 850 Cases = $90,100
Salling Price of Cases = $120,700
Cashflow of the Year = 120,700 - 90,100 = $30,600
Since the Salling price and cost price will rise with 6% each year.
Therefore Cashflow will also rise with 6% each year.
Tax Rate = 36%
NPV of the Project is to be calculated with the cost of capital 12%
NPV = -170,000 + (30,600*(1-0.36))/1.12 + (30,600*(1-0.36)*(1.06))/1.12^2 + ...
= -170,000 + ( (30,600*(1-0.36))/1.12 ) / (1 - 1.06/1.12)
= -170,000 + 326,400
= $156,400
Therefore, The NPV of the project is $156,400.