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Inflation effect

AGArnob Gomes8y ago
Sir, Does the inflation affect the NPV? There's a question that in not understanding. A project has an outflow, then a series of inflow at the end of each year and then finally sales proceeds. The NPV is £12,000. And inflation is zero. If the inflation rise to 7% per year with the revenues affected but the initial expenditure and resale value not subjected to inflation, what would happen to NPV? please Sir help me out with this one! Thank you
John MoffatJohn MoffatTutor8y ago#1
On what you have written, inflation will mean that the revenue cash flows (and hence the net cash flows) will be higher than when there is zero inflation. If the net cash flows are higher then the NPV will be higher also. You cannot calculate an exact new NPV because there is not enough information.
AGArnob Gomes8y ago#2
Yes Sir, that is exactly what I have figured... But the Kaplan Revision kit answer says the opposite. They say there would be fall in NPV. It is written- "The revenue flows will be subjected to inflation, but then should be discounted at a money rate. The net effect is no change in the NPV. The sales proceeds represent a flow of money, not affected by inflation, but this will now be discounted at a money rate, lowering the net present value of the project." Question is from Kaplan MCQ no.75 Sorry for the lenghty posts Sir.
John MoffatJohn MoffatTutor8y ago#3
Ooops - I answer too quickly last time, and I was wrong. Sorry :-( Kaplan are correct (although they should have worded it better - as you have copied it, then it could be read several ways). We should discount the actual cash flows at the actual/nominal cost of capital. As general inflation increases, so too will the nominal cost of capital. In theory, the PV of the sales proceeds will not change from before - higher cash flow discounted at higher cost of capital (I explain how this works, and why, in my free lectures). However the other inflows are not inflating - they will be the same as before - but will be discounted at a higher cost of capital. This means that the PV of them will be lower, and therefore the NPV overall will be lower.
AGArnob Gomes8y ago#4
Thank you so much Sir. Sorry for not watching your videos earlier but will watch them for sure. Thanks for helping!! ?
John MoffatJohn MoffatTutor8y ago#5
You are welcome :-)
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