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Hi sir
Can you help me out please
Why was the cost of capital 10 percent used for discounting the cash flows?
In the question it stated that there is currently an inflation target of 2 percent
I assumed that we had to calculate the real discount factor to take into consideration the inflation?
Can you kindly explain to me why was the inflation not taken into consideration please?
Thanks in adv.The question says that the expenditure estimates include any expected future cost increases, and therefore they are the actual/nominal flows and should be discounted at the actual/nominal cost of capital of 10%.
With regard to the inflows, the question tells you what formula to use, and the formula accounts for the inflation.
Thank you sir for the reply.
Since the operating surplus is expected to rise in line with the nominal GDP, what about the inflation? It is not going to be affected by the inflation
I still cannot understand this partThe df of 10 percent was used in the formulae. How is the inflation accounted in the formulae?
We want to discount an inflating flow at 10%.
If it was not inflating then you would simply use the annuity factor at 10% from the tables. Because it is inflating, the question says at the end that you should calculate the discount factor using the formula – the formula calculates the annuity factor at the real rate and we are then discounting the real cash flow (i.e. with no inflation) and the real cost of capital (i.e. with no inflation).
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