When analysing a project, if the expected future cash flows are denominated in nominal dollars, then the discount rate should represent a nominal rate as well.

Question

Quizplus · Accepted Answer

If the expected future cash flows are denominated in nominal dollars, then the discount rate should represent a nominal rate as well. This is because nominal cash flows already incorporate expected inflation, so the discount rate should also include a premium for expected inflation. If a real discount rate were used instead, the analysis would overstate the value of future cash flows since it would not account for the expected inflation.

When Analysing a Project, If the Expected Future Cash Flows