If the inflation rate was positive the expected NPV of an investment would be:
A) understated if real cash flows were discounted by the nominal discount rate.
B) understated if nominal cash flows were discounted by the nominal discount rate.
C) overstated if the real cash flows were discounted by the nominal discount rate.
D) understated if the nominal cash flows were discounted by the real discount rate.
E) overstated if the real cash flows are discounted by the real discount rate.

Question

Quizplus · Accepted Answer

CWhen real cash flows are discounted by the nominal discount rate, the expected NPV is overstated because the nominal discount rate includes inflation, thus not accurately reflecting the real purchasing power of future cash flows. Conversely, it is understated because the real cash flows should be discounted at a real discount rate to accurately reflect their present value without the distortion of inflation.

If the Inflation Rate Was Positive the Expected NPV of an Investment