A company is analyzing a capital investment project in a high-inflation environment. The nominal cash flows have been estimated. The company's weighted average cost of capital (WACC) is a nominal rate. How should the company proceed with the Net Present Value (NPV) calculation?

Answer options:

Discount the nominal cash flows using the nominal WACC.

Discount the nominal cash flows using the real WACC.

Adjust the nominal cash flows to real cash flows and discount using the nominal WACC.

Inflation is irrelevant to NPV calculations.

How to approach this question

Match the cash flows with the rate. Nominal matches Nominal. Real matches Real.

Full Answer

A.Discount the nominal cash flows using the nominal WACC.✓ Correct

To obtain an accurate NPV, one must be consistent. Nominal cash flows (which include expected inflation) must be discounted at the nominal rate (which includes an inflation premium). Using a real rate on nominal flows would overstate the value.

Common mistakes

Mixing real and nominal figures.

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