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Dear sir
Could you please explain the difference between ‘real after tax cost of capital’ and ‘nominal after tax cost of capital’ and when do we use them?
Thank you
The nominal after tax cost of capital (or the money cost of capital) is the actual weighted average cost of capital and is applied to the actual (nominal) cash flows after inflating them as necessary.
The real (or effective) cost of capital is the WACC after removing the inflation, and is applied to the cash flows without inflation (i.e. the current price flows).
The relationship between the real cost of capital and nominal cost of capital is given on the formula sheet (the Fisher formula).
Unless specifically told to do differently in the exam, we always calculate the actual (nominal) cash flows and discount at the actual (nominal) cost of capital.
This is dealt with in the free lectures on investment appraisal with inflation.
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