When making capital-budgeting decisions, the effects of inflation
A) should be ignored since it is impossible to know what future inflation rates will be.
B) are important, but it is impossible to estimate their effects on capital-budgeting decisions.
C) act to reduce the minimum desired rate of return on projects.
D) act to increase the minimum desired rate of return on projects.

Question

Quizplus · Accepted Answer

Inflation reduces the purchasing power of a currency over time, which means that future cash flows will be worth less than present cash flows. As a result, inflation acts to increase the minimum desired rate of return on projects, as companies will need to earn a higher return to compensate for the decreased purchasing power of future cash flows. Therefore, when making capital-budgeting decisions, it is important to consider the effects of inflation and adjust the minimum desired rate of return accordingly.

When Making Capital-Budgeting Decisions, the Effects of Inflation