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Sir, please help with this doubt. When adjusting for inflation in cashflows, the current cashflows are inflated by specific rate to get nominal cashflows then its deflated by general rate to arrive into real cashflows. We have studied that current price does not take into account for inflation however in text it is written “current cash flows ie real terms”. If real and current cashflows are same why does we again inflating the current cash flows by specific and deflating it with general as these cashflows only include specific rate right? Please help sir. Its a request!
When adjusting for inflation in cash flows, the current cash flows are inflated by a specific rate to get nominal cash flows. However, it is important to note that the term “current cash flows” in this context refers to cash flows in real terms, meaning they are already adjusted for inflation.
The term “current” here does not mean that these cash flows are not affected by inflation.The reason for inflating the current cash flows by a specific rate and then deflating them by the general rate is to account for the difference between specific inflation rates applicable to individual cash flows and the general rate of inflation.
By deflating the nominal cash flows by the general rate of inflation, we can obtain the real cash flows, which represent the cash flows without inflation.How to explain these in simpler terms sir? I am mentoring a set of students and they came up with this doubt.
Current are inflated @ various rates = Nominal then deflate @ “general inflation “ to get to the real rate
Current cash flows truly represent the cash flows at current prices, while real cash flows represent the cash flows adjusted for inflation. In order to convert these current cash flows to real cash flows, the specific inflation rates applicable to each cash flow component are used to inflate these to nominal cash flows.
These nominal cash flows are then deflated by the general rate of inflation to obtain the real cash flows.This process is necessary because different cash flow components may experience different rates of inflation, and the general rate of inflation may not accurately reflect the specific inflation rates of each component. By adjusting for inflation, the real cash flows provide a more accurate representation of the purchasing power of the cash flows.
So again….
Current are inflated @ various rates = nominal then deflate @ “general inflation “ to get to the real rate
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