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Came across a question (section c), it had different inflation for sales, v.c and f.c, they also gave us a general inflation rate, gave both money cost of capital and real cost of capital, clear my confusion on this because i thought regarding real rate we dont inflate cashflows and outflows, but in the answer (they required both npvs, using nominal and real c.o.c) the did nominal npv using the specifc inflation rates and for real npv they used general inflation rate to inflate cashflows and outflows.
and in another question only a general inflation rate is given and that is used to calculate nominal/money npv, and real npv is calculated without inflation
Nominal NPV Calculation
When calculating the nominal NPV, you should inflate all cash flows (sales, variable costs, and fixed costs) using their specific inflation rates. This means you apply the specific inflation rates to each cash flow item to arrive at the nominal cash flows. Then, you discount these nominal cash flows at the nominal cost of capital.
Real NPV Calculation
For the real NPV, the approach is different. You typically do not inflate the cash flows. Instead, you would use the general inflation rate to adjust the nominal cash flows to real cash flows. This involves deflating the nominal cash flows by the general inflation rate to remove the effects of inflation. After obtaining the real cash flows, you would discount them at the real cost of capital.
General vs. Specific Inflation
The general inflation rate is used to convert nominal cash flows to real cash flows when calculating the real NPV. In contrast, specific inflation rates are applied to individual cash flow items when calculating the nominal NPV.
Different Questions
In the case where only a general inflation rate is provided, you would use this rate to calculate the nominal NPV directly. For the real NPV, you would not apply any inflation, as you are working with real cash flows.
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