Explain the use of real and nominal discount rates in discounting cash flows. Which is used more often and why?
What will be an ideal response?
The most important thing to remember is that real cash flows should be discounted at the real interest rate and nominal cash flows should be discounted at the nominal discount rate. Since real cash flows do not include inflation, discounting real cash flows at the nominal rate will artificially reduce the NPV and lead the analyst to reject projects that otherwise should be accepted. Likewise, since nominal cash flows do include inflation, they must be discounted at the nominal discount rate which includes inflation. Discounting nominal cash flows at the real discount rate will result in an artificially high NPV and thus lead to accepting projects that should otherwise not be accepted. Since most cash flows are nominal, nominal rates are used more often in practice.
You might also like to view...
In the PAF cost model, PAF stands for ______.
A. prevention, appraisal, failure B. planning, action, feedback C. prevent, act, feedback D. planning, appraisal, feedback
Answer the following statements true (T) or false (F)
The equity method is questionable in terms of both relevance and representational faithfulness.
Obviously it is I who ____ to blame for the error in our income statement
A) is B) am
Trial and error play a major role in developing a compensation strategy.
Answer the following statement true (T) or false (F)