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. You earn 6% on all your current investments. The economists, however, have forecasted that inflation may rise by 1% or may fall by 1% over the next 5 years. Inflation will only influence the opportunity cost since the cash inflows are fixed.
a. Calculate the net present value (NPV) of the investment under the current required rate of return.
b. Calculate the net present value (NPV) of the investment under a period of rising inflation.
c. Calculate the net present value (NPV) of the investment under a period of falling inflation.
d. Based on your answers in parts a, b, and c, describe the relationship between changes in inflation and asset valuation.