A firm is considering a project that has cash flows indexed to the consumer price index.What discount rate should be chosen?

Question

Quizplus · Accepted Answer

A rate that uses the consumer price index in its measure, such as the real interest rate, is the best choice for discounting cash flows indexed to the consumer price index. This ensures that the cash flows are being discounted at a rate that reflects the inflation rate and maintains the purchasing power of the future cash flows. Using nominal discount rate or yield to maturity would not account for changes in the inflation rate, and using the change in consumer price index alone would not account for the time value of money.

A Firm Is Considering a Project That Has Cash Flows