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Dear Sir John Moffat,
when we do project appraisal through Money term approach, we inflate the cash flow according to the relevant inflation rate & use Monetary wacc to discount those cash flow…
but there could be another scenario that our annual cash flows are fixed (eg. paying annual insurance premiums) meaning that these cash flows would’nt inflate as inflation rises irrespective of the inflation rate in the country, so in this kind of scenario whether we are to use Monetary Wacc or Real Wacc for discounting?
let me give an example of such case: assume that we are to pay fixed 50,000 annual premium for 20 years and at the end of 20th year we will get 4Million inflow (like happens in Insurance policy), we assume that inflation rate in country would be 10% YoY and we require just 2% Real Return; How should we do its appraisal? What would be the discount rate i.e money rate or real rate?You are referring to the nominal approach.
We calculate the actual (nominal cash flows) and discount at the nominal (actual) cost of capital.
If the cash flows are fixed then we obviously do not inflate them
If we are only given the real cost of capital then we need to calculate the nominal cost of capital in the way I explain in the lectures (i.e. by using the formula and using the general rate of inflation).
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