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$5.00 Inflation Adjustment / Project Risk
- From Business: Finance , Economics: Financial-Markets
- Closed, but you can still post tutorials
- Due on Jan. 06, 2008
- Asked on Dec 23, 2007 at 2:09:46PM
Q:Inflation Adjustment: 2 Questions based on information provided below:
The Rodriguez Company is considering an average-risk investment in a mineral water spring project that has a cost of $ 150,000. The project will product 1,000 cases of mineral water per year indefinitely. The current sales price is $ 138 per case, and the current cost per case (all variable) is $ 105.
The firm is taxed at a rate of 34%. 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 15%. Assume that cash flows consist only of after-tax profits, since the spring has an indefinite life and will not be depreciated.
a> Should the firm accept the project ?
( Note: the project is a perpetuity, so you must use the formula for a perpetuity to find its NPV, and all calculations should be shown)
b> If total costs consisted of a fixed cost of $10,000 per year and variable costs of $ 95 per unit, and if only the variable costs were expected to increase with inflation, would this make the project better or worse ? Continuing the assumption that the sales price would rise with inflation.
