An investment related to developing a new product is estimated to have the following costs and revenues in today dollars. Do not consider any tax issues.
(a) Evaluate the project's escalated dollar IRR if both capital costs and operating costs are estimated to escalate at 15% per year from time zero and income is estimated to escalate at 10% per year from time zero.
(b) Evaluate the project's escalated dollar IRR assuming a "washout" of escalation of income and operating costs with a 15% escalation of capital costs per year. "Washout" means any operating cost escalation is offset by the same dollar escalation of revenue (not the same percentage escalation) so that the before-tax profit remains uniform.
(c) Compute the constant dollar IRR of case (b) assuming that the rate of inflation will be 10% per year.