In the analysis John drew your attention to the fact that whereas you were using the market-determined nominal cost of capital as the discount rate, the sales price and operating cost per unit were assumed to remain constant throughout the project's life. This raised the following questions
a. What are the problems with an analysis in which the discount rate is in nominal terms but the cash flows are measured in current dollar terms, unadjusted for inflation?
b. If cash flows are to be adjusted for inflation, is it appropriate to assume that inflation is neutral, i.e., that inflation has the same impact on all elements of the cash flow stream?
a. What are the problems with an analysis in which the discount rate is in nominal terms but the cash flows are measured in current dollar terms, unadjusted for inflation?
If the discount rate is in nominal terms but the cash flows are measured in current dollar terms, unadjusted for inflation then there is problem of inconsistency. Thus the numerator (cash flow) in the NPV calculations is unadjusted for inflation while the discount rate in the ...
Solution Summary
The solutions discusses the problems associated with adjusting cash flows for inflation when evaluating a project.
... think it is necessary to adjust for inflation... expected NPV if the inflation adjustment is made ... Initial Investment (100,000) Total cash flow (100,000) 37,333.33 ...
... required rate of return and adjust the cash... required rate of return without adjusting the cash...Inflation Adjusted: After tax Year Outlay Savings savings MACRS ...
... terminal cash flows when the real estate is sold, leaving it higher with more extreme inflation or not much higher with low inflation. Second, you adjust the ...
... by Vic, You realize that the revenue and cost figures have not been adjusted for inflation...Adjust the data and recalculate the relevant cash flows. ...
... of operations, cash flow, accelerated depreciation, average tax rate, capital budgeting, present value, required rate of return, adjustment for inflation. ...
... The cash flow from a bond comes from the interest ... we must evaluate performance on a risk-adjusted basis. ... be constructed from the Index, after adjusting for the ...
... Nominal cash flows at nominal discount rate and the result is similar to real cash flows discounted at real discount rate. Thus Adjusted Inflation NPV etc. ...
