7-4b.- Inflation and Capital Budgeting Example

7-4b.- Inflation and Capital Budgeting Example - Inflation...

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1 Inflation and Capital Budgeting: An Example
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2 Inflation, Real, and Nominal Rates The relationship between interest rates and inflation (the Fisher relationship) is: (1 + Nominal Rate) = (1 + Real Rate) × (1 + Inflation Rate) For low inflation rates this is approximated as Real Rate 2245 Nominal Rate – Inflation Rate While the nominal U. S. rate has fluctuated with inflation, most of the time the real rate has exhibited far less variance. RULE: When adjusting for inflation in capital budgeting, one must compare real cash flows discounted at real rates or nominal cash flows discounted at nominal rates.
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3 Information for Example Sony has an investment opportunity to produce a new stereo color TV. The required investment on January 1 of this year is $ 32 million. The firm will depreciate the investment to zero using the straight-line method over 4 years. The tax rate is 34%. The price of the product on January 1 will be $ 400 /unit. This price will stay constant in real terms.
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This note was uploaded on 01/15/2010 for the course FIN 357 taught by Professor Hadaway during the Fall '06 term at University of Texas at Austin.

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7-4b.- Inflation and Capital Budgeting Example - Inflation...

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