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Dear Sir:
For the following question, I am going with option c). Since I am pretty sure about part 2 which is true, as we have to include the inflation in our future cash flows. However, excluding inflation from the cash flows looks not a sensible or ideal scenario to me and that is why I am favoring false for this part. Please advise.
Thanks, Shams
To deal with the effect of inflation when appraising investment projects, two possible approaches can be used. These are:
1. To exclude inflation from the estimated future cash flows and to apply a discount rate expressed in real terms.
2. To adjust the estimated future cash flows by the relevant rates of inflation and to adjust the discount rate to reflect the current market rates.Which one of the following combinations is correct?
Please answer in the following order: Statement 1 / 2.
a) True / True
b) True / False
c) False / True
d) False / FalseHi Shams
Although I will give you an answer, this question cannot possibly be asked in Paper F3 (only in Paper F2).
Both statements are true.
The reason is that in theory, interest rates go up and down with the rate of inflation.
So…..if we ignore inflation in both the cash flows and also in the discount rate (which is what is meant by ‘real’ terms) then either way should be OK in theory 🙂
thank you sir. at least it is good that i was right about the second part. for your information, i am preparing for both paper 2 and 3. thanks again
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