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CAPITAL INVESTMENT APPRAISAL
Inflation
• ALWAYS BE CONSISTENT: Money / nominal cash flows should be discounted at a money /
nominal rate of return and real cash flows should be discounted at a real rate of return.
• Formula: (1 + n) = (1 + r)(1 + i) Includes inflation
• Where n = money / nominal rate of return,
r = real rate of return, and
i = inflation rate
Excludes inflation
Example:
Where a real rate of return is 20% and the inflation rate is 10% then the nominal rate of return is:
(1 + n) = (1 + r)(1 + i)
(1 + n) =(1,20)(1,10)
∴ n = 32%
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