I have the following question from my homework:
When calculating the net present value of an investment project, the firm of Henry & Norman expects profit in the first year to be $60,000, and they expect real profits to remain at that level over the next five years.
Since they are using nominal discount rate of 11 percent in their net present value calculation, they want to convert future real profits to nominal profits. They expect inflation to be 4 percent per year over the next five years.
The nominal profit for year 2 of the investment project is ___________(correct answer, 62,400)
If the investment project has an initial cost of 200,000, the net present value in nominal dollars is _________ (my answer 64,474.50 book answer 38,264.90)
The difference between the book answer and my answer is that I used 60,000 as year 1 profit with no discount. I realized this was incorrect according to the given methodology in my textbook of $NPV=-C+\pi_1/(1+R)+\pi_2/(1+R)^2+...$
What I don't understand is why we discount the profits in year one but don't consider inflation in year one. This seems inconsistent to me. Why do we discount the real profit in the first year and not the nominal profit, or if we assume nominal profits in year one are the same as real profit, why do we discount in year one?