3. Inflation in project analysis

It is often easy to overlook the impact of inflation on the net present value of the project. Not incorporating the impact of inflation in determining the value of the cash flows of the project can result in erroneous estimations.

Consider the following scenario:

Galaxy Corp. is considering opening a new division to make iGadgets that it expects to sell at a price of $12,450 each in the first year of the project. The company expects the cost of producing each iGadget to be $7,225 in the first year; however, it expects the selling price and cost per iGadget to increase by 4% each year.

Based on this information, complete the following table:

Selling price in year 4:
Cost per unit in year 4:

If a company does not take inflation into account when analyzing a project, the expected net present value (NPV) of the project will typically belower than the true NPV of the project.