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Chapter 4

1.2 The impact of inflation on cash flows

Cash flows that have not been increased for expected inflation are described as
being in current prices or today’s prices.

Cash flows that have been increased to take account of inflation are known as
money cash flows or nominal cash flows. They represent the expected cash
outflow or inflow to hit the bank account.

Assume in the exam that cash flows are money cash flows unless stated
otherwise.

Objectives

Methods of dealing with
inflation

Money/nominal
Real Method

method

Do NOT inflate the cash flows Inflate each cash flow by its
– leave them in current terms specific inflation rate i.e.
i.e. in today’s (t0) prices – convert it to a money cash

current cash flows flow

Discount using the real rate Discount using the money rate

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

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