A B C D E F G 1 INFLATION AND THE REAL RATE OF INTEREST 2 3 4 Interest rate 12.00% 5 Inflation rate 5.00% 6 7 Real interest rate 6.67% ( 1 + Interest Rate ) / ( 1 + Inflation Rate ) - 1 8 9 10 EXAMPLE 11 12 Cash today 100.00 13 Plus interest 12.00 14 Cash next year 112.00 15 16 Price today 106.67 17 Plus inflation 5.33 18 Price next year 112.00
H
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A B C INFLATION AND CONSTANT DOLLAR FACTORS Current price Inflation rate Year Price Inflation factor 200.00 5.00% 0 200.00 100.00% 1 210.00 105.00%
D
E
F
2 220.50 110.25%
3 231.53 115.76%
Inflation Factor = Previous Inflation Factor x ( 1 + Inflation Rate ) Price Constant dollar factor Price in constant dollars 200.00 100.00% 200.00 210.00 95.24% 200.00 220.50 90.70% 200.00 231.53 86.38% 200.00
Constant dollar factor = 1 / Inflation Factor Constant dollar factor = Previous Constant Dollar Factor / ( 1 + Inflation Rate )
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A B C D E NPV CAN BE CALCULATED IN NOMINAL OR REAL TERMS Interest rate Inflation rate Real interest rate Year Cash flow PV factor PV of cash flow Cumulative PV NPV Cash flow Constant dollar factor Real cash flow Real PV factor Real PV Cumulative real PV NPV 12.00% 5.00% 6.67% 0 1 2 3 300,000 71% 213,534 62,259
F
G
H
(400,000) 100,000 200,000 100% 89% 80% (400,000) 89,286 159,439 (400,000) (310,714) (151,276) 62,259 (400,000) 100,000 200,000 100% 95% 91% (400,000) 95,238 181,406 100% 94% 88% (400,000) 89,286 159,439 (400,000) (310,714) (151,276) 62,259
300,000 86% 259,151 82% 213,534 62,259
Cash Flow x Const $ Factor Real CF x Real PV Factor
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