A certain investment will require an immediate cash outflow of $4m. At the end of each ofthe next 4 years, the investment will generate cash inflows of $1.25m. a) Assuming that these cash flows are in nominal terms and that the nominal discount rate is 10.25%, calculate the projects NPV. b) Now assume that the expectedd rate of inflation is 5% per year. Recalculate the projects cash flow in real terms, discount htem at the real interest rate, and verify that you obtain the same NPV. Hint: find the reall cash flows by adjusting the values of cash flows by the 5% inflation rate. Then using the equation of real rate and nominal rate, determine the real rate of return.

Question

A certain investment will require an immediate cash outflow of $4m. At the end of each ofthe next 4 years, the investment will generate cash inflows of $1.25m.

a) Assuming that these cash flows are in nominal terms and that the nominal discount rate is 10.25%, calculate the projects NPV.

b) Now assume that the expectedd rate of inflation is 5% per year. Recalculate the projects cash flow in real terms, discount htem at the real interest rate, and verify that you obtain the same NPV.

Hint: find the reall cash flows by adjusting the values of cash flows by the 5% inflation rate. Then using the equation of real rate and nominal rate, determine the real rate of return.

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