I have this capital budgeting question in my Corporate Finance course (book Brealey, Myers, Allen) with the all assumptions below. I know how to set it up in excel, but I am confused about how to deal with the inflation, considering that sales and prices are discounted to year one? I get the wrong npv result in the end, so I would like to know what I need to think about in this question. (Also, to see how stock prices changes considering the optimal debt ratio, does this mean that we use wacc when discounting? Because otherwise it would be APV to account for financing side effects, but ofcourse those were not given).

If someone could do somewhat of a step by step, that would be very helpful.

Expected annual sales: 37,000 units Expected price per unit in year 0 prices: 525 That is annual sales are estimated to be 19.425 million in year 0 prices Expected annual inflation rate: 1.5 percent. . . The necessary equipment is expected to be purchased and installed just after New Year, i.e. Jan- uary 1st year 1 .The equipment would fall into the MACRS 5-year class, and it would cost 19 million. The project requires an initial investment of 3.5 million in net working capital. The project's estimated economic life is six years. At the end of year 6 the necessary equipment is estimated to be obsolete and have no significant salvage value Variable costs are estimated to be 47 percent of sales Fixed costs, excluding depreciation, is estimated to be 6 million a year in year 0 prices. Depreciation expenses would be determined for the year in accordance with the MACRS rates 20.00, 32.00, 19.20, 11.52, 11.52 and 5.76 The marginal corporate tax rate 1s 35 percent. Assume debt is risk free . * * * . The risk free rate is 3 percent per annum. The expected market risk premium is 5.5 percentage points XYZ Corporation has 65,000 stocks outstanding The project's optimal debt-to-value ratio is 45% and is assumed to be constant. The management team has gathered the following information on five corporations specializing in production of widgets (using Brealey, Myers and Allen's notation) an HI JK LM OP 0.94 0.77 0.73 0.89 0.82 D/E 1.25 0.95 1.15 1.15 0.85 The management team asks you to evaluate the widget project by estimating the expected change in stock price if the project is all equity financed, and if the project is financed using the project's op- timal debt ratio. The management team of XYZ Corporation would also like to know the project's internal rate of return