(1 + Nominal rate) = (1 + Real rate) (1 + Inflation rate). In general, the relationship between real and nominal rates is: Nominal cash flows should be discounted at a nominal discount rate, and real cash flows should be discounted at a real rate. Whereas, real cash flows are adjusted downward to remove the effect of inflation. Nominal cash flows include the effects of inflation. The share price should increase from $50 to $55.Įffects of Inflation on Capital Allocation processĬapital allocation analysis can be done either in ‘nominal’ terms or ‘real’ terms. Since there are 100 million shares outstanding, each share should go up by 500/100 = $5. The overall value of company should increase by $500 million because of the project. What is the likely impact of the project on the stock price? The company currently has 100 million shares outstanding and each share has a price of $50. But, if the project’s profitability is less than expectations, then the stock price may be negatively impacted.Ī company is undertaking a project with an NPV of $500 million.
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