- This topic has 5 replies, 4 voices, and was last updated 3 years ago by
.
- Posts
Pinks Co Mar/Jun 19 – BPP Exam kit Q150.
for a) ii) Can I do real NPV based on current cashflow values (not inflated) given in question and discounting at real rate? Would I get any marks for this way?
Or do i have to deflate the inflated cashflows by general inflation rate?
Thanks
You would not lose all of the marks but you would lose some.
The reason is that the flows are inflating at different rates that the general inflation rate.
I’m actually trying to understand Pinks Co. Question 32 a part (ii) of this question. Please explain how they arrive at the real cash flows before tax. I thought the real cash flows were simply using the forecasted data given without adjusting for inflation. I am looking at the answer, but not understanding how they arrived at the following real cash flows before tax.
Y1 $13,643,
Y2 $22408,
Y3 $35,823,
Y4 $8,975Please explain
The nominal cash flow at time 1 is 14,148.
The general rate of inflation is 3.7%.
Therefore the real cash flow = 14,148 / 1.037 = $13,643The nominal cash flow at time 2 is 24,097
Therefore the real cash flow (removing two years inflation) is 24,097 / (1.037^2) = $22,408It is the same logic for the other two 🙂
what’s the logic behind deflating when we have real values and real discount rate?
why need to deflate the nominal values?The ‘real’ cash flows are the nominal cash flows with the general rate of inflation removed. The ‘real’ cost of capital is the nominal cost of capital with the inflation removed.
It is actually a rather silly exercise for the examiner to ask, but he has done so twice.
I do explain the relationship between the real and nominal cash flows and the real and nominal cost of capital in my free lectures.
- You must be logged in to reply to this topic.