Assume that sales revenues are increasing more rapidly than product costs, but that a project's cash flows have been represented as an annuity when calculating NPV.Which of the following problems may occur?
A)nominal cash flows are possibly being discounted with a real rate.
B)real cash flows are possibly being discounted with a nominal rate.
C)nominal cash flows are possibly being discounted with a nominal rate.
D)real cash flows are possibly being discounted with a real rate.

Question

Quizplus · Accepted Answer

If sales revenues are increasing more rapidly than product costs, this is an indication of inflation. Therefore, the cash flows should be discounted using a real rate to account for inflation. However, if the cash flows are represented as an annuity, they may be discounted using a nominal rate instead, which would result in the incorrect valuation of the project.

Assume That Sales Revenues Are Increasing More Rapidly Than Product