NPV using real and nominal rates

MMahrukh8y ago

Hi Sir, Going through bpp textbook, I just read that ''it is important to take account of inflation when appraising any investment, as it could change the npv & hence the final decision.'' Isn't it that npv calculated using real cash flows discounted at the real rate of return would be exactly the same as nominal cash flows discounted using nominal rate? or is it so, just in theory, not practically? If both npv's turn out to be different, which one is preferrable and why?

John MoffatTutor8y ago#1

The NPV's will be the same, but only if all of the cash flows are quoted at current prices and if all of the cash flows are inflating at the same general rate of inflation. In practice that is unlikely to be the case, and in the exam it is almost never the case and therefore we need to discount the nominal cash flows at the nominal cost of capital. (The only time in the P4 exam that you are likely to need to use the real cost of capital on the current price flows is when there is a perpetuity, because it is the only possible way to deal with it.)

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