Poulsen Industries 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.No change in net operating working capital would be required.This is just one of many projects for the firm,so any losses on this project 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 inflation adjustment is required.What is the difference in the expected NPV if the inflation adjustment is made versus if it is not made?
A)$12,018
B)$12,650
C)$13,316
D)$13,982
E)$14,681

Question

Poulsen Industries 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.No change in net operating working capital would be required.This is just one of many projects for the firm,so any losses on this project 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 inflation adjustment is required.What is the difference in the expected NPV if the inflation adjustment is made versus if it is not made? 
A)$12,018 
B)$12,650 
C)$13,316 
D)$13,982 
E)$14,681

Quizplus · Accepted Answer

Making the inflation adjustment results in an increase in the variable costs and the sales price each year. This reduces the cash flows over time, which leads to a lower NPV. The difference in the expected NPV between not making the inflation adjustment and making it is $13,316 (the NPV without the inflation adjustment is $50,000 and with the inflation adjustment is $36,684). Therefore, the best choice is to adjust for inflation, as it provides a more accurate estimation of the project's value.

Poulsen Industries Is Analyzing an Average-Risk Project,and the Following Data