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We have two independent and mutually exclusive projects, A and B. Project A requires an initial...

We have two independent and mutually exclusive projects, A and B. Project A requires an initial investment of $1000, and will yield $500 of cash inflows for the next three years. Project B requires an initial investment of $3,500, and will yield $1,000 of cash inflows for the next five years. The required return on both projects is 10%

What is the real rate of return based on the exact Fisher equation?

1 + R = (1+r)x (1+h)

1+ .10 = (1+r) x (1+0.03)

r = 1.10 / 1.03 -1

Real Rate of Return = 6.796% = 6.8%

A. What are the real cash flows from Project A and Project B?

B. What are the real net present values of Project A and Project B? (Hint: The real NPV should be the same as the nominal NPV.)

C. Which project should be chosen based on the real cash flows and real rate of return?

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Home nert Page Layout Formulas Data Review View dd-Ins Cut E AutoSum ー E ゴWrap Text aCopy в 1 프 . Ej-., Δ. : rーー 逻锂函Merge & Center. $, % , 弼,8 C Conditional Format CeInsert Delete Format Formatting, as Table w styles. ▼ ㆆ ▼ Sort &Find & 2 ClearFe Select Edting Format Painter Clipboard Alignment Number Cells D30 29 A 30 31 PROJECT A 32 REAL NET CASH FLOW YEAR CFAT REAL CASHFLOW (AFTER INCORPORATING INFLATION) 34 35 36 37 38 PROJECT B 39 40 41 42 43 515.00 (500 (1+0.03)) 530.45 (515 (1+0.03)) 546.36 (530.45 (1+0.03)) REAL NET CASH FLOW YEAR CFA REAL CASHFLOW (AFTER INCORPORATING INFLATION) 1000 1000 1000 1000 1000 1030.00 (1000 (1+0.03)) 1060.90 (1030 1+0.03)) 1092.73 AND SO ON 1125.51 1159.27 4 45 46 47 1 | YTC, NPV 3 ASSETS NPV | real dat . allocation amorti LOAN OPTIONS . SPLIT VALUE OF SHARE . HPR REAL RETURN (EPS BEST PLAN EAC HIGH LOW . Sheet1 , 02-01-2019Home nert Page Layout Formulas Data Review View dd-Ins Cut Σ AutoSum ー E ゴWrap Text aCopy B 1 u. ,_a. ars-函Merge & Center, $, % , 弼,8 C Conditional Format CeInsert Delete Format Formatting as Table Styles2 Clear Sort &Find & Format Painter Clipboard Alignment Number Cells Edting 48 49 B 50 PROJECT A 51 52 53 54 CALCULATION OF REAL NPV REAL CASHFLOW PV FACTOR @ 10% NOTE REAL CASHFLOWS TO BE DISCOUNTED WITH NOMINAL RATE OF RETURN YEAR PV OF CASHFLOW 1000 515.00 530.45 546.36 0.9091 0.8264 0.7513 NPV- 1000.00 468.18 438.39 410.49 317.06 56 57 PROJECT B 58 59 60 61 62 63 YEAR REAL CASHFLOW PV FACTOR @10% 0 PV OF CASHFLOW 3500 1030.00 1060.90 1092.73 1125.51 1159.27 0.9091 0.8264 0.7513 0.6830 0.6209 3500.00 936.36 876.78 820.98 768.74 719.82 622.68 4 65 66 C DECISION: PROJECT B SHOULD BE SELECTED 44 YTC NPV 3 ASSETS NPy real cfat country allocationamorti LOAN OPTIONS SPLIT VALUE OF SHAREHPR REAL RETURN EPS BEST PLAN EAC HIGH LOW Sheetl 02-01-2019Home nert Page Layout Formulas Data Review View dd-Ins Cut Σ AutoSum 11 -A ーータ·Δ· ー E ゴText Wrap Text General B l U. s『 Merge & Center. $, % , n,a conditional Format Cell Insert Delete Format チFormat Painter Clipboard 2 ClearFe Select Edting Alignment Number Cells G76 ID 70 B 71|PROJECT A 72 73 74 75 76 CALCULATION OF NOMINAL NPV NOTE ON PV FACTOR YEAR NOMINAL CF PV FACTOR @6.796% (REAL RATE) PV OF CASHFLOW -1000 500.00 500.00 500.00 0.9364 0.8768 0.8210 1000.00 468.18 438.39 410.49 317.06 1/(1+0.06796)A0 1/(1+0.06796)A1 1/(1+0.06796)A2 1/(1+0.06796)A3 78 79.PROJECT B 80 81 82 83 84 85 86 87 88 C YEAR NOMINAL CF 0 PVFACTOR @6.796% PVOFCASHFLOW 3500 1000.00 1000.00 1000.00 1000.00 1000.00 0.9364 0.8768 0.8210 0.7687 0.7198 3500.00 936.36 876.78 820.98 768.74 719.82 622.69 NOTE NOMINAL CF SHOULD BE DISCOUNTED WITH REAL RATE 4 BOTH METHODS WILL GIVE SAME ANSWER DECISION: 3 ASSETS NPV real cfat merger PROJECT B SHOULD BE SELECTED 44 YTC NPV country allocation am ort LOAN OPTIONS SPLIT VALUE OF SHARE PR REAL RETURN EPS BEST PLAN EACHİGH LON -Sheet1 n 02-01-2019

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