Question 7.EX.3.4: NPV calculation involving inflation Thorne plc is planning...
NPV calculation involving inflation
Thorne plc is planning to sell a new electronic toy. Non-current assets costing €700,000 would be needed, with €500,000 payable at once and the balance payable after one year. Initial investment in working capital of €330,000 would also be needed. Thorne expects that, after four years, the toy will be obsolete and the disposal value of the non-current assets will be zero. The project would incur incremental total fixed costs of €545,000 per year at current prices, including annual depreciation of €175,000.
Expected sales of the toy are 120,000 units per year at a selling price of €22 per toy and a variable cost of €16 per toy, both in current price terms. Thorne expects the following annual increases because of inflation:
If Thorne’s real cost of capital is 7.5 per cent and taxation is ignored, is the project viable?
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