Corporate finance
1 / 36

Corporate Finance - PowerPoint PPT Presentation

  • Uploaded on

Corporate Finance. Lecture 4. Topics covered. Inflation in capital budgeting Interest rate and inflation rate Discounting with inflation Investment with unequal lives. Inflation and capital budgeting. Interest rates and inflation

I am the owner, or an agent authorized to act on behalf of the owner, of the copyrighted work described.
Download Presentation

PowerPoint Slideshow about 'Corporate Finance' - winola

An Image/Link below is provided (as is) to download presentation

Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author.While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server.

- - - - - - - - - - - - - - - - - - - - - - - - - - E N D - - - - - - - - - - - - - - - - - - - - - - - - - -
Presentation Transcript

Topics covered
Topics covered

  • Inflation in capital budgeting

    • Interest rate and inflation rate

    • Discounting with inflation

  • Investment with unequal lives

Inflation and capital budgeting
Inflation and capital budgeting

  • Interest rates and inflation

    • The effect of inflation: The time value of money is deflated by inflation.

    • Real interest rate vs. nominal interest rate


  • Be consistent in how you handle inflation!

    • Use nominal interest rates to discount nominal cash flows.

    • Use real interest rates to discount real cash flows.

    • Notice the treatment of depreciations in the two approaches: Depreciation is a nominal number!

Inflation and capital budgeting1
Inflation and capital budgeting

  • Approximation

    • Real interest rate ≈

      Nominal interest rate – Inflation rate

    • The approximation is reasonably accurate when the interest rate and the inflation rate are low.

    • Example. Monarchy of Gerberovia has a norminal interest rate of 300% and inflation rate of 280%.

      • (1+300%)/(1+280%)-1=5.26%

      • 300%-280%=20%



You own a lease that will cost you $8,000 this year, increasing at 3% a year (the forecasted inflation rate) for 3 additional years (4 years total). If discount rates are 10% what is the present value cost of the lease?


Example - nominal figures


Example - real figures

Cash flows and discount rates an example
Cash flows and Discount rates: An example

Inflation rate =10%

Norminal rate =15.5%

Discount with the real rate5
Discount with the real rate


Real rate=

Investments of unequal lives
Investments of unequal lives

  • So far, the NPV rule has been our rule-of-thumb.

  • However, there are situations when the NPV rule is not sufficient.

  • E.g. when investments under decision have different lengths of life.

Investments of unequal lives1
Investments of unequal lives

Discount rate=0.1

Investments of unequal lives7
Investments of unequal lives

NPV rule will suggest Machine A because it has a lower NPV of costs……But, is this correct?

Investments of unequal lives8
Investments of unequal lives

  • The NPV rule does not consider the time that each machine will last.

    • Machine A is cheaper but only last for three years.

    • Machine B is more costly but last for one more year.

  • Therefore, it is necessary to compare the cost on a per year basis.

Investments of unequal lives10
Investments of unequal lives

  • Annuity

  • A: 798.42=C1*


    B: 916.99=C2*


    C1>C2, it is cheaper to buy machine B