Hello Sir,
in this particular lecture, i understood that the real cost of capital should be used for cash flows that are to continue in perpetuity. But what should we do when the annuity cash flows are to grow from a particular year to perpetuity ? like lets say from year 4 to perpetuity?
Regards.
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Lecture on relevant cash flows and inflation
8y ago#1Again, because it is a perpetuity we have no choice but to use the real cost of capital.
You discount the perpetuity by multiplying by 1/r (where r is the real cost of capital) and then you discount for 3 years (because the perpetuity starts 3 years late - it starts are time 4 instead of at time 1) to get back to the present value.
However, better is to use the dividend valuation formula (even though they are not dividends, the formula can be used for any inflating perpetuity to get the present value), but again to then discount the answer for another three years because the perpetuity starts 3 years late). I work through an example of this in my lectures on the valuation of securities.
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