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ACCA Applied Skills · Financial Management · Allowing for inflation and taxation in DCF

Zeta Co requires a real return of 6% and expects general inflation of 4% a year. Using the Fisher relationship, what is the money (nominal) discount rate Zeta should use for discounting money cash flows?

The money discount rate is 10.24%. The Fisher formula multiplies one plus the real rate by one plus inflation, so 1.06 times 1.04 equals 1.1024. Simply adding the two rates gives 10%, which ignores compounding and is therefore not exact.

  1. A10.24%Correct
  2. B10.00%
  3. C2.00%
  4. D9.76%

Explanation

Money rate = (1.06 x 1.04) - 1 = 1.1024 - 1 = 10.24%. Simply adding 6% and 4% to get 10% ignores the compounding cross-product, so it is slightly too low. Subtracting the rates gives about 2%, which is the wrong direction.

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