Sylvester Media is analyzing an average-risk project, and the following data have been developed. Unit sales will be constant, but the sales price should increase with inflation. Fixed costs will also be constant, but variable costs should rise with inflation. The project should last for 3 years, it will be depreciated on a straight-line basis, and there will be no salvage value. This is just one of many projects for the firm, so any losses can be used to offset gains on other firm projects. The marketing manager does not think it is necessary to adjust for inflation since both the sales price and the variable costs will rise at the same rate, but the CFO thinks an adjustment is required. What is the difference in the expected NPV if the inflation adjustment is made vs. if it is not made?
Project cost of capital (r)10.0%
Net investment cost (depreciable basis)$200,000
Units sold50,000
Average price per unit, Year 1$25.00
Fixed op. cost excl. deprec. (constant)$150,000
Variable op. cost/unit, Year 1$20.20
Annual depreciation rate33.333%
Expected inflation4.00%
Tax rate25.0%
A. $15,330
B. $16,136
C. $16,986
D. $17,835
E. $18,727
Answer: C
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