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Read explanation in bpp afm many times, but cannot understand the idea. Nominal rate we inflate prior to discounting. If we do not inflate and use the real rate would the effect be the same? Or these are two different approaches? Followed an example with machine cost 300k usd and was not sure if to inflate and use nominal or do not onflate an calculate real. Thank you and BR?
Both approaches result in the same answer.
However in Paper AFM, it is very unlikely that the real rate will be relevant. Virtually always we calculate the actual (nominal) cash flows and discount at the actual (nominal) cost of capital. The reason is that there are always different flows inflating at different rates, and it would be far too messy to bother using real rates.
It will help you to watch my free Paper FM lectures on investment appraisal with inflation where this is all explained (because this is revision from Paper FM) 🙂
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