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AM Co will receive a perpetuity starting in 2 years time of $10,000 per annum, increasing by the rate of inflation (2%).
What is the present value of this perpetuity assuming a money cost of capital of 10.2%?Please explain me this question and why do we take real rate here?
To use the nominal rate of 10.2% would mean discounting the actual cash flows (with inflation). Because it is a perpetuity this would be impossible – you cannot list all the nominal cash flows for a perpetuity!!
Therefore we discount the real cash flows (ignoring inflation) at the real discount rate (i.e. without inflation).
I do explain the relevance and logic of using the real cost of capital in my free lectures.
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