Inflation Adjustments

The Rodriguez Company is considering an average-risk investment in a mineral water spring project that has a cost of $170,000. The project will produce 1,050 cases of mineral water per year indefinitely. The current sales price is $144 per case, and the current cost per case is $115. The firm is taxed at a rate of 32%. Both prices and costs are expected to rise at a rate of 7% per year. The firm uses only equity, and it has a cost of capital of 14%. Assume that cash flows consist only of after-tax profits, because the spring has an indefinite life and will not be depreciated.

1. What is the NPV of the project? Do not round intermediate calculations. Round your answer to the nearest dollar. (Hint: The project is a growing perpetuity, so you must use the constant growth formula to find its NPV.)

   $

   Should the firm accept the project?

   -Select-No/Yes

2. Suppose that total costs consisted of a fixed cost of $8,500 per year plus variable costs of $85 per unit, and only the variable costs were expected to increase with inflation. Would this make the project better or worse? Continue to assume that the sales price will rise with inflation.

   This will make the project

3. -Select- better/ worse.