Cash Flows: Cash flows are the incomings and outgoings of cash in and from the business. There are two types of cash flows namely, real cash flows and nominal cash flows. Real cash flows are those cash flows that a company expects to receive or pay in future after adjusting the inflation. Inflation may vary every year, hence taking it in account is important. Thus, real cash flows are more appropriate for decision making. Nominal cash flows are those cash flows that a company expects to receive or pay in the future period, without any adjustment for inflation. Discount Rates Discount rates are the interest rates at which the future cash flows are discounted to calculate the present cash flows. There are two types of discount rates namely, real discount rates and nominal discount rates. Real discount rate is the interest rate, arrived at after adjusting for inflation, used to discount the cash flows. Nominal discount rate is the interest rate, arrived at without adjusting for inflation, used to discount the cash flows. To determine: The mistake made when real cash flows are discounted with nominal discount rates.

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Chapter 5, Problem 5CT

Summary Introduction

Cash Flows:

Cash flows are the incomings and outgoings of cash in and from the business.

There are two types of cash flows namely, real cash flows and nominal cash flows.

Real cash flows are those cash flows that a company expects to receive or pay in future after adjusting the inflation. Inflation may vary every year, hence taking it in account is important. Thus, real cash flows are more appropriate for decision making.

Nominal cash flows are those cash flows that a company expects to receive or pay in the future period, without any adjustment for inflation.

Discount Rates

Discount rates are the interest rates at which the future cash flows are discounted to calculate the present cash flows.

There are two types of discount rates namely, real discount rates and nominal discount rates.

Real discount rate is the interest rate, arrived at after adjusting for inflation, used to discount the cash flows.

Nominal discount rate is the interest rate, arrived at without adjusting for inflation, used to discount the cash flows.

To determine:

The mistake made when real cash flows are discounted with nominal discount rates.

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