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Hi John,
I have reviewed the lecture notes and example of real interest rates before attempting question 32 part a)ii) however I cannot get the same answer as the question for the real cash flows before tax.
I have used the formula and it does give me the same 8% as the effective cost of capital but I am not getting the same answer. Can you advise?
The general rate of inflation is 3.7%, so to get the real cash flows you take the nominal cash flow (in the first year it is 14148) and divide by 1.037 to ‘eliminate’ the inflation. 14148/1.037 = 13643.
Similarly for the second year, except it is for 2 years and so you need to divide by 1/(1.037)^2, and so on.
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