Inflation Rate

When assuming the interest rate or discount rate, one must not forget the inflation rate. The rate of inflation may be assumed as a variable every year or a fixed value, and there are studies and economic research to calculate the rate of inflation. Its value differs from one country to another according to the nature of a country’s economy observed over time. The following equation calculates the highest rate of return and includes the rate of inflation:

The nominal interest rate of return ^ 5)

= (l+inflation rate) (1+interest rate)-l.

Inflation Rate Подпись: 1.0577 Подпись: (3.7)

The previous example includes an interest rate of 10% and assumes an inflation rate of 4%. The real interest rate or discount rate is figured by the following equation:

Table 3.7 Net present value including inflammation

Year

(1)

(2)

(3)=(l)x (2)

(4)

(5)=(4)x (3)

Net Cash Flow

Inflation

Rate

Net Cash Flow After Inflation

Discount

Rate

Net

Present

Value

0

-51785

1.0

-51785

1.0

-51785

1

20000

0.96

19231

0.95

18182

2

20000

0.92

18491

0.89

16529

3

20000

0.89

17780

0.85

15026

4

20000

0.85

17096

0.80

13660

Sum (NPV)

11612

When the inflation rate is constant, the net present value is stable under the assumption that the rate of return is fixed. When the dif­ference value of the interest rate changes every year, the net present value will be different.