Page 113 - 5.2 i. Manac Finance ITC Summarised Notes

CAPITAL INVESTMENT APPRAISAL

Inflation

Various revenues and costs rise at the same rate as general inflation.

• Where synchronized inflation is applicable, it may be easier to ignore
inflation.

• However, for exam purposes convert the real rate to a nominal rate and
adjust the cash flows for inflation.

Various revenues and costs do not all rise at the same rate as general inflation
(i.e. general inflation is 10% pa but wages increase at 20% pa).

• However, should differential inflation be applicable the rates and cash
flows must be adjusted for inflation (no choice).

NOTE: The interest rate used to discount future cash flows (WACC)
incorporates inflation (i.e. it is a nominal rate) therefore to be consistent
the cash flows should also incorporate inflation.

NB: In a question you can assume the rate and the cash flows given
include inflation unless otherwise stated.

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