Extensive Enterprise Inc. is considering opening a new division to make iWidgets that it expects to sell at a price of $14,950 each in the first year of the project. The company expects the cost of producing each iWidget to be $5,500 in the first year; however, it expects the selling price and cost per iWidget to increase by 3% each year.

Based on this information, select the correct answer:

It is often easy to overlook the impact of inflation on the net present value of the project. Not incorporating the impact of inflation in determining the value of the cash flows of the project can result in erroneous estimations. Consider the following scenario: Extensive Enterprise Inc. is considering opening a new division to make iWidgets that it expects to sell at a price of $14,950 each in the first year of the project. The company expects the cost of producing each iWidget to be $5,500 in the first year; however, it expects the selling price and cost per iWidget to increase by 3% each year. Based on this information, select the correct answer:
If a company does not take inflation into account when analyzing a project, the expected net present value (NPV) of the project will typically be higher/lower? than the true NPV of the project. |