Mustang Enterprises Inc has been considering the purchase of

Mustang Enterprises, Inc., has been considering the purchase of a new manufacturing facility for $290,000. The facility is to be fully depreciated on a straight-line basis over seven years. It is expected to have no resale value after the seven years. Operating revenues from the facility are expected to be $125,000, in nominal terms, at the end of the first year. The revenues are expected to increase at the inflation rate of 2 percent. Production costs at the end of the first year will be $50,000, in nominal terms, and they are expected to increase at 3 percent per year. The real discount rate is 5 percent. The corporate tax rate is 35 percent. ar2 pe year Calculate the NPV of the project. (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) NPV

Solution

NOMINAL DISCOUNT RATE:
=(1+real)*(1+inflation)-1
=1.05*1.02-1=7.1%
NOMINAL CASH FLOWS:
free cash flow at the end of year 1=(125000-50000-290000/7)*(1-35%)+290000/7=63250
free cash flow at the end of year 2=(125000*1.02-50000*1.03-290000/7)*(1-35%)+290000/7=63900
free cash flow at the end of year 3=(125000*1.02^2-50000*1.03^2-290000/7)*(1-35%)+290000/7=64553.25
free cash flow at the end of year 4=(125000*1.02^3-50000*1.03^3-290000/7)*(1-35%)+290000/7=65209.52
free cash flow at the end of year 5=(125000*1.02^4-50000*1.03^4-290000/7)*(1-35%)+290000/7=65868.58
free cash flow at the end of year 6=(125000*1.02^5-50000*1.03^5-290000/7)*(1-35%)+290000/7=66530.16
free cash flow at the end of year 7=(125000*1.02^6-50000*1.03^6-290000/7)*(1-35%)+290000/7=67194

NPV=-290000+63250/1.071+63900/1.071^2+64553.25/1.071^3+65209.52/1.071^4+65868.58/1.071^5+66530.16/1.071^6+67194/1.071^7=59276.16