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Please John can you tell me the difference between real and norminal cost of capital and when to use which as a discount rate . thank you
The nominal rate is the actual cost of capital and is used on the actual cash flows (i.e. including inflation).
The real rate is the cost of capital if there were no inflation, and is used on the ‘real’ cash flows – i.e. the cash flows at current prices.
It is rare that using the real rate is relevant in the exams – usually we inflate the flows to get the nominal/actual cash flows, and discount at the actual cost of capital.
To get the actual/nominal cost of capital if we are given the real cost of capital, we use the Fisher formula on the formula sheet (using the general rate of inflation for ‘h’).
Therefore when we usually answer question ( like NPV and etc), and if they provide us the cost of capital , it refers to the nominal cost of capital ?
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