FINFries | SFM/AFM | Chp 3 - 2 | Interest Rates #AFM #FINfries

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In this FINfry we have explained cashflow after tax:

Adjustment for inflation is a necessity for capital investment appraisal. This is because inflation will
raise the revenues & costs of the project. The net revenues after adjustment for inflation shall be
equal to net revenues in current terms. The considerations, which cause distortion, are:
(1) Depreciation charges are based on historical costs. Tax benefits accruing from depreciation
charges do not keep parity with inflation.
As annual after-tax cash inflow of a project is equal to
(R – C – D) (1 – T) + D = (R – C) (1 – T) + DT
Where,
R → Revenue from project
C → Costs (apart from depreciation) relating to the project
D → Depreciation charges
T → Tax Rate
Here (R – C) (1 – T) tends to move in line with inflation as inflation influences revenues & costs
similarly. DT does not depend on inflation as depreciation charges are based on historical costs.
The effect of inflation is to reduce the actual rate of return.

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[DheebhanMahalingamVoiceWorks]

Basically, Real Interest Rates are those interest rates that are arrived without giving effect to Inflation Rates.

Whereas, Nominal Interest Rates are those interest rates which are arrived at after giving effect to Inflation Rates, along with Real Interest Rates, that is after multiplying (1+R)(1+I).

(1+N) = (1+R)(1+I)

Similarly,

(1+R) = (1+N) ÷ (1+I)

Hence the relation between Nominal Rates and Real Rates are always multiplied by or divided by after adding 1 to it, that is (1+ ). No adding or subtracting after that.

Thanks Sir 🙏