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Hello Sir,
in the following example
13. A company is appraising a three-year project that requires an initial outlay on 1 January 20X4 of $30,000. The project is expected to give the following cash inflows on 31 December of each year:
20X4 $10,000
20X5 $20,000
20X6 $25,000
All of the above cash flows are before taking account of specific annual inflation of 5% per year. The nominal cost of capital is 14%.Using a nominal approach and the discount tables provided, what is the NPV of the project on 1 January 20X4 (to the nearest $)? (Answer in $ in the Answer box)
Could you please explain why in the answers they use the 5% as discount factor instead of the 14%, when it explicitly says – to use a nominal approach (which means not incl inflation?).
Thank you in advance
The discount factor of 5% is used in the calculation of the NPV because it takes into account the specific annual inflation rate of 5% per year mentioned in the example. When using a nominal approach, the cash flows need to be adjusted for inflation before discounting them.
By applying the discount factor of 5%, the cash flows are EFFECTIVELY inflated to their nominal values and then discounted at the nominal cost of capital of 14%. This ensures that both the cash flows and the cost of capital are expressed in nominal terms, allowing for a consistent analysis.
Have you tried to inflate by 5% and discount at 14%?
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