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fm12 8 - 12-6 a Sales = 1,000($138 Cost = 1,000($105 Net...

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12-6 a. Sales = 1,000($138) $138,000 Cost = 1,000($105) 105,000 Net before tax $ 33,000 Taxes (34%) 11,220 Net after tax $ 21,780 Not considering inflation, NPV is -$4,800. This value is calculated as -$150,000 + 15 . 0 780 , 21 $ = -$4,800. Considering inflation, the real cost of capital is calculated as follows: (1 + r r )(1 + i) = 1.15 (1 + r r )(1.06) = 1.15 r r = 0.0849. Thus, the NPV considering inflation is calculated as -$150,000 + 0849 . 0 780 , 21 $ = $106,537. After adjusting for expected inflation, we see that the project has a positive NPV and should be accepted. This demonstrates the bias that inflation can induce into the capital budgeting process: Inflation is already reflected in the denominator (the cost of capital), so it must also be reflected in the numerator.
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