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Discounted cash flows (Inflations nominal rate)

Forums › Ask ACCA Tutor Forums › Ask the Tutor ACCA AFM Exams › Discounted cash flows (Inflations nominal rate)

  • This topic has 1 reply, 2 voices, and was last updated 6 years ago by John Moffat.
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  • Author
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  • May 16, 2018 at 7:12 am #452226
    ggwillhappen
    Member
    • Topics: 17
    • Replies: 8
    • ☆

    Hello sir,

    In the current notes page 56 there is a paragraph stated as below:

    “As stated earlier, it is unlikely that you will be expected to use this approach – usually you will inflate cash flows and then discount at the nominal rate. However do watch for the situation where you are given the real cost of capital and the general rate of inflation. In this case you will still inflate the cash flows to get the actual cash flow, but will need to use the Fisher equation to calculate the nominal cost of capital”

    But if cash flows without inflation and the real (effective) cost of capital is given why cant we just discount it at that rate. Why as mentioned above are we first inflating the cash flows then calculating the nominal rate and then discounting?

    Regards,

    May 17, 2018 at 3:27 pm #452459
    John Moffat
    Keymaster
    • Topics: 57
    • Replies: 54655
    • ☆☆☆☆☆

    If every flow was to inflate at the same, general rate of inflation, then what you say would be fine.

    However in real-life it will never be the case that all flows inflate at the same general rate, and it is very unlikely to be the case in the exam.

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