We have two independent and mutually exclusive projects, A and B. Project A requires an initial investment of $1000, and will yield $500 of cash inflows for the next three years. Project B requires an initial investment of $3,500, and will yield $1,000 of cash inflows for the next five years. The required return on both projects is 10%.

The cash flows and required return given are all in nominal terms. Given that the inflation rate is 3%, answer the following questions:

d. What is the real rate of return based on the exact Fisher equation? (1 mark)

e. What are the real cash flows from Project A and Project B? (2 marks)

f. What are the real net present values of Project A and Project B? (Hint: The real NPV should be the same as the nominal NPV.) (2 marks)

g. Which project should be chosen based on the real cash flows and real rate of return?