Skip to content

ACCA Strategic Professional · Advanced Financial Management · Discounted cash flow techniques

A company is appraising a project using a nominal (money) cost of capital. Which treatment of cash flows is consistent?

When the cost of capital is a nominal rate, cash flows should be inflated to future money values, using specific inflation rates for each item where they differ, and then discounted at that nominal rate. This keeps the cash flows and the discount rate on the same basis.

  1. ADiscount cash flows expressed in current prices at the nominal rate
  2. BInflate cash flows at their specific inflation rates and discount at the nominal rateCorrect
  3. CInflate cash flows at the general rate only and discount at the real rate
  4. DIgnore inflation in cash flows and discount at the real rate with taxes inflated

Explanation

Nominal cash flows must be discounted at a nominal rate, which includes inflation expectations. Using cash flows in current prices with a nominal rate double-counts inflation in the rate only and understates NPV. Specific inflation rates should be applied to each flow where they differ.

Did you get it right without looking?

One question tells you little. A timed set on Discounted cash flow techniques shows your real accuracy, how long you take and where you lose marks.

Practise Discounted cash flow techniquesFree diagnostic mock

More Discounted cash flow techniques questions