Problem 12-48 Payback, Net Present Value, Internal Rate of Return, Intangible Benefits, Inflation Adjustment Objective 1, 2, 3, 4, 6 Foster Company wants to buy a numerically controlled (NC) machine to be used in producing specially machined parts for manufacturers of trenching machines (to replace an existing manual system). The outlay required is $3,500,000. The NC equipment will last 5 years with no expected salvage value. The expected incremental after-tax cash lows (cash fows of the NC equipment minus cash flows of the old equipment) associated with the project follow: EXCEL Year Cash Benefits $3,900,000 3,900,000 3,900,000 3,900,000 3,900,000 Cash Expenses $3,000,000 3,000,000 3,000,000 3,000,000 3,000,000 2 3 4 Foster has a cost of capital equal to 10%. The above cash flows are expressed without any consideration of inflation. Required: 1 Compute the payback period Answer 2. Calculate the NPV and IRR of the proposed project Answer 3. Conceptual Connection Inflation is expected to be 5% per year for the next 5 years. The discount rate of 10% is composed of two elements: the real rate and the inflationary element. Since the discount rate has an inflationary component, the projected cash flows should also be adjusted to account for inflation. Make this adjustment, and recalculate the NPV. Comment on the importance of adjusting cash flows for inflationary effects. Answer Original investment $3,500,000 Annual cash flow - $900,000 Payback eriod 3.89 Payback period 2. Year Cash Flow Discount Factor 1.00000 1.05000 0.82640 Present Value $(3,500,000 $ (3,500,000) 900,000 900,000 900,000 900,000 900,000 2 4 5 NPV P - CF(df)- I for the IRR, thus, Investment Annual cash flow Discount factor Discount factor (df)- The discount factor relates to an IRR of about Year Cash Flow Discount Factor Present Value $ (3,500,000) 945,000 992,250 1,041,863 1,093,956 1,148,653 2 4 5 NPV [Key essay answer here]