Question 3.16 Part 3

Hello,

Part (ii) of the question is on setting the discount rate.

First sentence in the solution is
If the cashflows are real, ie expressed in today's monetary terms, then a real discount rate should be chosen. If nominal, ie expressed in absolute terms, then a nominal rate should be used.

Am not very clear on real and nominal cashflows. If my expense in first year is 100 and xecond year is 100 + 5% due to inflation, hence 105, and 3rd year is 110, say (for simplicity), and I want to discount the numbers 100, 105 and 110 for 1,2 and 3 years respectively, then will the rate used be called REAL discount rate or NOMINAL discount rate.

Suppose the WACC is 8%. How is this 8% supposed to take care of the above requirement. ie how will the 8% differ and what is this different calculation, or is the WACC only called Real or Nominal depending on the cashflow being discounted.

Thanks.

 

Here your outflow is, 100+ inflation
That means real outflow of 100, so you'd use real risk discount rate.

So if 8% WACC is based on real-return expectation, you'd use this.