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Having watched your lectures, I understood the logic of the actual and real cost of capital
But in the BPP Revision Kit, question 110, the concept was tested with perpetuities and I don’t understand why (in the answer) they had to compute the perpetuity factor using the real cost of capital. Is it because the perpetuity was not inflated?
Then shouldn’t inflating the perpetuity but using the actual cost of capital to determine perpetuity factor produce the same result?
In general, the two methods give the same results.
Either we inflate the flows and then discount at the actual cost of capital, or alternatively we do not inflate the flows and discount at the real cost of capital.Usually we use the first method (because usually different flows inflate at different rates).
However when it is a perpetuity we have no choice and have to use the second method. Think about it – if it is only 4 years there is no problem inflating each flow, but it is impossible to keep inflating each flow when they continue for ever!! You would run out of paper, let alone out of time 🙂
Ooh.. That’s true though.. Thanks for clearing that out.. This exam definitely require lots of critical thinking..
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