Income taxes, inflation. James Delusio, plant manager of Peoria Metal Works, is consider¬

ing an investment in special tools of $240,000 on December 31, 2007. The tools have an esti¬

mated useful life of four years and a $24,000 terminal disposal price. The tools will enable Peoria to manufacture drill bits to very high tolerances without incurring any incremental costs, and to earn additional cash flows of $2.40 per unit in 2008, $2.54 in 2009, $2.70 in 2010, and $2.86 in 2011. Peoria expects to sell 35,000 units each year for the next four years.

Peoria is subject to a 40% tax rate. The after-tax required rate of return is 18%. The tools qualify for a capital cost allowance rate of 35%, declining balance.

Required 1. Compute the net present value ofthe project.

2. Delusio feels that inflation will persist for the next four years at the rate of 6% per year.

Elowever, the 18% minimum desired rate of return already includes a return required to cover the effects of anticipated inflation. Repeat requirement 1, to take inflationary effects into consideration.

3. Could you have taken inflation into account in a way different from what you did in requirement 2? Broadly describe how without actually performing any calculations.