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Explanation Note: Intermediate answers are shown below as rounded, but the full answer was used to complete the calculetion. Here we have the sales price and production costs in real terms. The simplest method to calculate the project cash flows is to use the real cash flows. In doing so, we must be sure to adjust the depreciation, which is in nominal terms. We could analyze the cash flows using nominal values, which would require calculating the nominal discount rate, nominal price, and nominal production costs. This method would be more complicated, so we will use the real numbers. We will first calculate the NPV of the headache only pill. Headache only. We can find the real revenue and production costs by multiplying each by the units sold. We must be sure to discount the depreciation, which is in nominal terms. We can then find the pro forma net income, and add back depreciation to find the operating cash flow. Discounting the depreciation each year by the inflation rate, we find the following cash flows each year: And the NPV of the headache only pill is: NPV=$21,000,000+$11,089,146/1.08+$11,045,598/1.082+$11,003,318/1.083NPV=$7,472,335.85 NPV=$7,472,335.85 Headache and arthritis: For the headache and arthritis pill project, the equipment has a salvage value. We will find the aftertax salvage value of the equipment first, which will be: Remember, to calculate the taxes on the equipment salvage value, we take the book value minus the market value, times the tax rate. Using the same method as the headache only pill, the cash flows each year for the headache and arthritis pill will be: So, the NPV of the headache and arthritis pill is: NPV=$29,000,000+$15,355,925/1.08+$15,295,787/1.082+($15,237,401+780,000)/1083NPV=$11,047,25078 The company should manufacture the headache and arthritis pill since that project has a higher NPV. Explanation Note: Intermediate answers are shown below as rounded, but the full answer was used to complete the calculetion. Here we have the sales price and production costs in real terms. The simplest method to calculate the project cash flows is to use the real cash flows. In doing so, we must be sure to adjust the depreciation, which is in nominal terms. We could analyze the cash flows using nominal values, which would require calculating the nominal discount rate, nominal price, and nominal production costs. This method would be more complicated, so we will use the real numbers. We will first calculate the NPV of the headache only pill. Headache only. We can find the real revenue and production costs by multiplying each by the units sold. We must be sure to discount the depreciation, which is in nominal terms. We can then find the pro forma net income, and add back depreciation to find the operating cash flow. Discounting the depreciation each year by the inflation rate, we find the following cash flows each year: And the NPV of the headache only pill is: NPV=$21,000,000+$11,089,146/1.08+$11,045,598/1.082+$11,003,318/1.083NPV=$7,472,335.85 NPV=$7,472,335.85 Headache and arthritis: For the headache and arthritis pill project, the equipment has a salvage value. We will find the aftertax salvage value of the equipment first, which will be: Remember, to calculate the taxes on the equipment salvage value, we take the book value minus the market value, times the tax rate. Using the same method as the headache only pill, the cash flows each year for the headache and arthritis pill will be: So, the NPV of the headache and arthritis pill is: NPV=$29,000,000+$15,355,925/1.08+$15,295,787/1.082+($15,237,401+780,000)/1083NPV=$11,047,25078 The company should manufacture the headache and arthritis pill since that project has a higher NPV

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