Question

Galaxy Corp. is considering opening a new division to make iToys that it expects to sell at a price of $15,250 each in the first year of the project. The company expects the cost of producing each iToy to be $6,700 in the first year; however, it expects the selling price and cost per iToy to increase by 3.00% each year.

Based on the preceding information and rounding dollar amounts to the nearest whole dollars, the company expects the selling price in the fourth year of the project to be_______ , and it expects the cost per unit in the fourth year of the project to be _______.
Which of the following statements about inflation’s effect on net present value (NPV) is correct?
A. When the selling price and cost per unit are expected to increase at the same rate, forgetting to take inflation into account in a capital budgeting analysis will typically cause the estimated NPV to be lower than the true NPV.
B. When the selling price and cost per unit are expected to increase at the same rate, you do not need to take inflation into account when performing a capital budgeting analysis.

Answer 1

Answer and Explanation:

The computation is shown below:

1

The calculation of the Expected selling price in the fourth year is

Expected Selling Price in year 1 $15,250

Expected Annual Growth rate is 3%

So,

Expected Selling Price in year 4 = 15250 × (1+3%)^3

= $16,664

2

The Calculation of Expected Cost per unit in the fourth year is

Expected Selling Price in year 1 = $6,700

Expected Annual Growth rate = 3%

So,

Expected Selling Price in year 4 = 6700 × (1+3%)^3

= $7,321

3

Inflation’s effect on net present value (NPV):

In the case when the selling price and the cost per unit rises at the similar rate so it is forgot to considered the inflation this will result in NPV that should be lower than the true NPV