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Hi,
sir, what would be the net effect of cash outflow( i.e repairs) and inflow( i.e scrap proceed) on the project NPV operating in inflationary economy?
will it fall as the outflow and/or inflow in this case will not move relative to the inflation rate but discounted at higher nominal cost of capital hence making it more expensive.
thanks,john.It depends on the rates of inflation applying to the different flows.
If all flows were to inflate at the general rate of inflation then in theory it would make no difference (because the WACC would increase also by the general rate of inflation).
However that is not realistic in real life because different types of flows inflate at different rates. That is why we calculate the nominal cash flows (inflating as relevant) and discount at the actual WACC.
sir as in the example of scrap proceed, wouldn’t it be a constant inflow as estimated in the cash flows because it is a fixed value paid out of already inflated income of the purchasing entity. after all it is a used machine and we will receive whatever the market value is at that point in time. could the valuation be altered by inflation in any way?
Scrap proceeds can be affected by inflation. For example, if the prices of new cars were to double then it is likely that the sale proceeds from an existing car would increase.
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