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Hello students, here is a question.
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You are trying to compare a present value of two separate streams of a cash flow that has an equivalent risk.
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One stream is expressed in nominal value and the other stream is expressed in real values.
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You decided to discount a nominal cash flow using a nominal annual rate of 8%.
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What rate you should you use for discount and real cash flow? so here ear of 8 % compounded monthly and 8 % of nominal rate minus the risk -free rate comparable risk -free rate and comparable real rate.
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So let us start solving this problem.
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So first we need to understand the difference between nominal and real values.
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So nominal values are expressed in the current dollars while real values are adjusted for inflation.
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Therefore, the real value reflects the purchasing power of a money over time.
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Next we need to discount the nominal cash flow using a nominal annual rate of 8%.
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This means that we are taking into an account the time value of a money but not inflation.
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To discount the real cash flow we need to use the rate of reflects both the time value of a money and inflation.
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One way to do this is equivalent annual rate that is ear...