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Hello John,
I have a question about PARA FUELS CO (SEP 22), for investment A, the answer says that you have to calculate the production costs to after-inflation amount.
I don’t understand why only the production cost is calculated in after-inflation amount, when the revenue, working capital, depreciation appears to be in nominal value.
Also doesn’t the cost of capital already include inflation? so I think it would make more sense to calculate everything in nominal value and discount it to take into account of the inflation.
When flows are inflating at different rates (as is usually the case, and is certainly the case here) we always calculate the actual cash flows and discount at the actual cost of capital.
The revenue has been inflated at the rates given in the question. The working capital effectively inflates because it is a % of revenue. TAD obviously does not inflate ever.
Have you watched my free lecture on investment appraisal (and if you are still unsure watch the Paper FM lectures on investment appraisal with inflation, because this part of the question is revision from Paper FM).
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