Assume that you have been appointed finance director of O.K. Ltd. The company is considering investing in the production of electrical products, with an expected life of three years. The data related to the project are given below: In thousand dollars Year Fixed assets 1 2 3 0 3,000 Sales Materials Other operating costs Depreciation Operating costs Earnings before tax Tax (20%) Net operating income 3,000 600 1,200 1,000 2.800 200 40 160 3,200 650 1,300 1,000 2,950 250 50 200 4,000 700 1,500 1,000 3,200 800 160 640 All of the above cash flow and earnings have been prepared in terms of current dollar value. You have the following additional information: (1) (2) (3) (4) Selling price and materials costs are subject to an inflation rate of 10% per year. Other operating costs are subject to an inflation rate of 5% per year. The fixed assets have no expected salvage value at the end of three years. The investment in net operating working capital is minimal and can be ignored. The company's nominal after-tax weighted average cost of capital is 15%. (5) Required: a. b. Why, is it true, in general, that a failure to adjust expected cash flows for expected inflation biases the calculated NPV downward? (2 marks) Adjust the cash flows to incorporate the impact of inflation. You can round the figure to the nearest thousand dollars. (8 marks) Calculate the NPV and IRR of the project. (4 marks) b. c. How does the modified IRR (MIRR) method correct some of the problems with the regular IRR? Calculate the MIRR of the project. (6 marks)