General Studies · Financial Management
A company is evaluating a long-term project using the Net Present Value (NPV) method. The project's cash flows are subject to a specific inflation rate of 5% per annum, while the general rate of inflation in the economy is 3% per annum. The company's nominal weighted average cost of capital (WACC) is 12%. Which of the following statements correctly describes the most accurate theoretical approach to this appraisal?
Verified Solution4 OptionsUpdated: October 2026👁️1 View
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- 1The 5% specific inflation should be ignored, and the T0 cash flows should be discounted using the general inflation rate of 3% as the discount rate.
- 2The nominal cash flows, incorporating the 5% specific inflation, should be discounted using the nominal WACC of 12%.✓
- 3The nominal cash flows must be deflated by the general inflation rate of 3% before being discounted by the nominal WACC of 12%.
- 4The current (T0) cash flows should be discounted using a real discount rate of approximately 8.7% to account for specific inflation.
Correct answer
The nominal cash flows, incorporating the 5% specific inflation, should be discounted using the nominal WACC of 12%.
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