Page 76 - FM Integrated WorkBook STUDENT 2018-19

Chapter 4

1.3 Specific and general inflation rates

Specific inflation rates affect specific cash flows

If using the money method, inflate the individual cash flows using each one’s specific
inflation rate

General inflation rates affect the investors’ overall required rate of return

Use the general inflation rate to calculate a real rate from a money rate or a money
rate from a real rate using the (1 + i) = (1 + r)(1 + h) formula.

The key is to be consistent – match the type of rate used with the type of cash flows.

To convert between different types of cash flows:

Inflate using specific rate
Current cash flows Money cash flows

Deflate using general rate
Money cash flows Real cash flows

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