The nominal revenue for Year 2 is calculated as $400,000 × (1 + .10 + .13), which is incorrect. The nominal revenue for Year 2 should be calculated as the real revenue for Year 2 multiplied by 1 + the inflation rate.
The information that the owner requires a real internal rate of return of 10% is irrelevant to solving this problem. The relevant rates are the 8% real growth rate expected in the industry and the expected 3% inflation rate. The Year 2 real revenue will be the Year 1 revenue multiplied by 1 + the expected industry growth rate of 8%: $400,000 × 1.08, or $432,000. The Year 2 nominal revenue will be the Year 2 real revenue multiplied by 1 + the expected inflation rate: $432,000 × 1.03, or $444,960.
The Year 2 real revenue is calculated as the Year 1 revenue multiplied by 1 + the owner’s required real internal rate of return of 10%, which is not correct. The owner’s required real internal rate of return is not relevant for this analysis. The forecasted industry growth rate of 8% should be used. The Year 2 nominal revenue of $453,200 is calculated as the incorrect Year 2 real revenue of $440,000 × 1 + the inflation rate. The correct Year 2 real revenue should be multiplied by 1 + the inflation rate to calculate the correct Year 2 nominal revenue.
The Year 2 real revenue is calculated as the Year 1 revenue multiplied by 1 + the owner’s required real internal rate of return of 10%, which is not correct. The owner’s required real internal rate of return is not relevant for this analysis. The forecasted industry growth rate of 8% should be used. The Year 2 nominal revenue of $452,000 is calculated as $400,000 × (1 + .10 + .13), which is incorrect. The nominal revenue for Year 2 should be calculated as the real revenue for Year 2 multiplied by 1 + the inflation rate.
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