ACCA Applied Skills · Financial Management · Allowing for inflation and taxation in DCF
Bolt Co expects a project to produce net cash inflows of $200,000 in Year 1 in current (Year 0) prices. Cash flows are expected to inflate at 5% a year and Bolt's money cost of capital is 12%. What is the present value of the Year 1 inflow?
The present value is $187,500. The Year 1 inflow must first be inflated to a money amount of $210,000 using 5% inflation, then discounted at the 12% money rate. Discounting the current-price figure directly would understate the value by mixing real cash flows with a nominal rate.
- A$178,571
- B$187,500Correct
- C$190,476
- D$200,000
Explanation
Money cash flow = 200,000 x 1.05 = 210,000. Discount at 12%: 210,000 / 1.12 = 187,500. Discounting the uninflated figure gives $178,571, which mixes real flows with a money rate.
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