4.2 General Discount Rate

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Problem. A project requires a current investment of $100.00 and yields future expected cash flows of

$21.00, $34.00, $40.00, $33.00, and $17.00 in periods 1 through 5, respectively. All figures are in

thousands of dollars. The forecasted inflation rate starts at 3.0% in period 1 and declines to 2.0% in period

5. For these expected cash flows, the appropriate REAL discount rate starts at 5.0% in period 1 and

increases to 6.5% in period 5. What is the net present value of this project?

Solution Strategy. We begin by calculating the (nominal) discount rate for each period from the inflation

rate in each period and corresponding real discount rate. The rest of the net present value calculation is

the same as the Net Present Value - General Discount Rate spreadsheet.

FIGURE 4.2 Spreadsheet for Real and Inflation - General Discount Rate.

How To Build Your Own Spreadsheet Model.

1. Start with the Net Present Value - General Discount Rate Spreadsheet, Insert Rows, And

Move One Item. Open the spreadsheet that you created for Net Present Value - General Discount

Rate and immediately save the spreadsheet under a new name using the File | Save As command.

Select the cell A8 and click on Insert | Rows. Select the cell A13 and click on Insert | Rows.

Select the range A9:G9, click on Edit | Cut, select the cell A13, and click on Edit | Paste.

2. Inputs. Enter the inputs in the range C8:G9.

3. Discount Rate. The formula for the (Nominal) Discount Rate = (1 + Inflation Rate) * (1 + Real

Discount Rate) - 1. Enter =(1+C8)*(1+C9)-1 in cell C13 and copy it across.

The Net Present Value of this project is $14.87. This spreadsheet can handle any pattern of inflation rates

and real discount rates. Of course, it can handle the special case of a constant inflation rates and constant

real discount rates.

Problem. A project requires a current investment of $100.00 and yields future expected cash flows of

$21.00, $34.00, $40.00, $33.00, and $17.00 in periods 1 through 5, respectively. All figures are in

thousands of dollars. The forecasted inflation rate starts at 3.0% in period 1 and declines to 2.0% in period

5. For these expected cash flows, the appropriate REAL discount rate starts at 5.0% in period 1 and

increases to 6.5% in period 5. What is the net present value of this project?

Solution Strategy. We begin by calculating the (nominal) discount rate for each period from the inflation

rate in each period and corresponding real discount rate. The rest of the net present value calculation is

the same as the Net Present Value - General Discount Rate spreadsheet.

FIGURE 4.2 Spreadsheet for Real and Inflation - General Discount Rate.

How To Build Your Own Spreadsheet Model.

1. Start with the Net Present Value - General Discount Rate Spreadsheet, Insert Rows, And

Move One Item. Open the spreadsheet that you created for Net Present Value - General Discount

Rate and immediately save the spreadsheet under a new name using the File | Save As command.

Select the cell A8 and click on Insert | Rows. Select the cell A13 and click on Insert | Rows.

Select the range A9:G9, click on Edit | Cut, select the cell A13, and click on Edit | Paste.

2. Inputs. Enter the inputs in the range C8:G9.

3. Discount Rate. The formula for the (Nominal) Discount Rate = (1 + Inflation Rate) * (1 + Real

Discount Rate) - 1. Enter =(1+C8)*(1+C9)-1 in cell C13 and copy it across.

The Net Present Value of this project is $14.87. This spreadsheet can handle any pattern of inflation rates

and real discount rates. Of course, it can handle the special case of a constant inflation rates and constant

real discount rates.