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

Galaxy Corp.

1. 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__$17,172___ , and it expects the cost per unit in the fourth year of the project to be ___$7,544___.

2. The CORRECT statement about inflation's effect on net present value (NPV) is:

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.

Step-by-step explanation:

a) Data and Calculations:

Expected selling price of iToy = $15,250 per unit

Expected cost of producing iToy = $6,700 per unit

Expected annual increase in selling price and cost per iToy = 3.00%

The expected selling price in the fourth year of the project = $15,250 * (1 + 0.03)^4

= $17,172 ($15,250 * 1.126)

The expected cost per unit in the fourth year of the project = $7,544 (6,700 * 1.126)