KopiPro is considering the purchase of a photocopying machine for $5,500 on December 31, 2012. It has a useful life of five years and a zero residual disposal price. Amortization will be applied on a straight-line basis. The cash operating savings are expected to be $1,350 annually, measured in December31, 2012, dollars. The discount factor is 18.8%, which includes the effects of anticipated inflation of 10%. Kopi Pro pays no taxes due to being a non-profit organization. The present values of $1 discounted at 18.8% received at the end of 1, 2, 3, 4, and 5 periods are 0.842, 0.709, 0.596, 0.502, and 0.423.
REQUIRED
1. A KopiPro official computed the net present value of the project using an 18.8% discount rate without adjusting the cash operating savings for inflation. What net present value figure did he compute? Is this approach correct? If not, how would you redo the analysis?
2.
(a) What is the real rate of return required by KopiPro for investing in the photocopying machine?
(b) Calculate the net present value using the real rate of return approach to incorporating inflation.
3. Compare your analyses in requirements 1 and 2. Present generalizations that seem appli cable about the analysis of inflation in capital budgeting.