Pensacola Cablevision Company provides television cable service to two counties in the Florida pan-handle. The firm’s management is considering the construction of a new satellite dish in December of 20×0. The new antenna would improve reception and the service provided to customers. The dish antenna and associated equipment will cost $200,000 to purchase and install. The company’s old equipment, which is fully depreciated, can be sold now for $20,000. The company’s president expects the firm’s improved capabilities to result in additional revenue of $80,000 per year during the dish’s useful life of seven years. The incremental operating expenses associated with the new equipment are projected to be $10,000 per year. These incremental revenues and expenses are in real dollars.
The new satellite dish will be depreciated under the MACRS depreciation schedule for the 5 year property class. The company’s tax rate is 40%.
Pensacola Cablevision’s president expects the real rate of interest in the economy to remain stable at 10%. She expects the inflation rate, currently running at 20%, to remain unchanged.
1. Compute the price index for each year from 20×1 through 20×7, using 1.000 as the index for 20×0.
2. Prepare a schedule of after tax cash flows measured in real dollars.
3. Compute the next present value of the proposed new satellite dish using cash flows measured in real dollars. Use a real discount rate equal to the real interest rate.