The appropriate discount rate that analysts use in computing the present value of future cash flows is composed of an increase reflecting the inflation expected to occur over the life of the project.Thus,

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The discount rate is composed of the risk-free rate plus a risk premium, and the risk-free rate includes an element of inflation. Therefore, the higher the expected inflation, the higher the risk-free rate, and consequently, the higher the discount rate. This is because higher inflation leads to higher future cash flows, and in order to discount those cash flows properly, a higher discount rate is required.

The Appropriate Discount Rate That Analysts Use in Computing the Present