Effective rate of interest

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Home › Forums › Ask ACCA Tutor Forums › Ask the Tutor ACCA F9 Exams › Effective rate of interest

This topic contains 1 reply, has 2 voices, and was last updated by Avatar of johnmoffat John Moffat 1 year ago. This post has been viewed 10 times

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  • November 30, 2012 at 12:17 pm #55966
    Avatar of rimx
    rimx
    Participant

    Hi John,
    can you tell me under what circumstances we can use effective rate of interest for discounting for investment appraisal ?
    As with capital allowances it wont fluctuate with inflation so will they be calculated separately with actual discount rate ?
    Also, what the effects of general inflation be on the working capital and will effective rate of interest be feasible for it too to discount ?

    December 1, 2012 at 3:13 pm #109279
    Avatar of johnmoffat
    John Moffat
    Keymaster

    The only time you would discount at the real (or effective) rate in the exam would be if you had an inflating annuity over a long period, which is unlikely.

    ALmost certainly any project will be short (4 or 5 years) and you will calculate the nominal (actual) cash flows and discount at the nominal (actual) WACC.
    If you are given the real cost of capital then you use the formula on the formula sheet to get the nominal (actual) cost of capital).
    1 + actual cost of capital = (1 + real cost of capital) x (1 + general inflation rate)

    Working capital and capital allowances are not then any problem because you are discounting the actual cash flows.

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