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Hello John.
Hope you’re doing well.The way I understand it, discounting figures (given at current prices) using the real cost of capital should give the same result, as inflating each figure using the general inflation rate, and discounting them using the nominal cost of capital. Correct me if I’m wrong here.
We are given the real cost of capital as 4.2% in this question. The way they’ve done it in BPP, is by inflating every figure, converting real COC into nominal COC, and then finally getting to the NPV. Instead, they could have kept the figures as they were, and used the real COC right?
I feel like I’ve learned this wrong. Would you please explain to me what that is?
Discounting at the real rate will only work if all the cash flows are inflating at the general rate of inflation. That is the case for most of the cash flows in this question (but not all of them), however the question specifically says (in note 1) that the cash flows are to be projected in nominal terms.
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