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    Inflation and capital budgeting

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    There are two ways to incorporate inflation into capital budgeting analysis. One way is to express cash flows in constant dollars (at the time of analysis) and adjust the discount rate by removing the inflation premium. Another way is to use the nominal discount rate while converting cash flows into current dollars (at the time of their expected occurrence). Which way do you prefer? EXPLAIN.

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    The second method is preferable. In the first method we would remove a single percentage from the discount rate to get the real rate. While inflation is usually given as a single rate, it is an average based on the basket of goods and services included in the index. Thus different goods and ...

    Solution Summary

    The solution explains the methods of incorporating inflation in capital budgeting