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How do you know whether you are working with real or nominal rates in the exam question if it doesn’t specifically mention either? In a Kaplan interim assessment, we are asked to calculate the NPV. We are told costs and revenues are given in real terms and we are also given variables to calculate Ke using CAPM but how do we know that the Ke we have calculated is real or nominal?
If you are calculating Ke yourself then it will always be the nominal rate. (The only exception would be if you were using CAPM and were given the real risk free rate and the real market return – however this is very unlikely)
How to judge whether to use money/rate, pls? I did a question before, after getting WACC, divided by inflation rate to get real rate, and then discount. Thank you.
You either apply the nominal rate (the actual WACC) to the nominal cash flows (actual cash flows), or you apply the real rate to the can flows at current prices.
Which to do really depends on the question.
If it is a 4 or 5 year project then you would usually inflate the cash flows to get the actual cash flows, and then discount at the actual WACC.
If it is a 10 or 15 year project, then it is extremely unlikely that you would be expected to inflate the flows. You would normally discount the flows at current prices at the real cost of capital.
Also, to be able to use the real cost of capital, it would need for all the cash flows to be growing at the same rate as the general rate of inflation.
1. Why if its 10 or 15yr project, why it would be unlikely for us to inflate the flOws ?
2 that means for us to use real cost of capital, all the cashflow items will be growing at t same rate ?
3. Is there ant past papers that have tested in this real inflation rate ? Because i couldnt see it so far ..
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