=+P12–7 Impact of inflation on investments The Choc Shop is considering buying new equipment with an initial investment outlay of $32,000. The equipment has a 5-year life with cash inflows in years 1 to 5 of $11,500, $12,000, $12,500, $10,000, and

$9,500, respectively. The current opportunity cost is 6% per year. However, the economists have forecasted that inflation may rise by 1% or may fall by the same amount over the next 5 years. Inflation will only influence the opportunity cost since the cash inflows are fixed.

Assume a direct positive impact of inflation on the prevailing rates (Fisher effect) and answer the following questions. (Assume that inflation has an impact on the opportunity cost, but that the cash flows are contractually fixed and are not affected by inflation.)