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Sir,
Please explain why they had to use a real rate in appraising the NPV of the Gas and Nuclear stations. They did not consider inflation for the cash flows.They have considered inflation – that is why they have used the real rate!!
We either discount the nominal (actual) cash flows at the nominal (actual) cost of capital, or alternatively discount the real (current price without inflation) flows at the real cost of capital.
By all means use the first alternative here – i.e. inflate the flows and then discount at the actual cost of capital – the answer will be the same. However, because there are so many years of flows and the fact that it is an annuity, it is far far quicker to use the second approach.
If you are still unclear as to the two ways of dealing with inflation then watch the Paper F9 lectures on investment appraisal with inflation (because this is revision of F9).
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