CFA Practice Question

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CFA Practice Question

Which one of the following methods would properly account for inflation when doing a capital budgeting analysis?
A. Use real cash flow figures when discounting them with nominal discount rate, or use nominal cash flows when discounting them with the real discount rate.
B. Because inflation is built in into the cash flow projections and the discount rate, we do not need to make any further adjustments to account for inflation.
C. Adjust for inflation, the capital cost components, before calculating the weighted average cost for the firm.
Explanation: The rule is that if you are using nominal operating cash flows in your forecast, then your discount rate also be in nominal form. On the other hand, if you are forecasting real cash flows, then you must adjust the nominal discount rate by subtracting from it the rate of inflation.

User Contributed Comments 1

User Comment
Olugbala should we always assume inflation is built into the cashflow projection and the discount rate?
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