Question
a.The constant prices approach assumes that the expected real increase in prices is zero. Briefly discuss an example where this assumption is invalid. b. Assume
a.The constant prices approach assumes that the expected real increase in prices is zero. Briefly discuss an example where this assumption is invalid. b. Assume that the annual revenues increase at the expected inflation rate of 5 percent and that accounts receivable are 10 percent of the annual revenues. What is the impact of the expected positive inflation rate on the present value of the cash receipts, relative to an expected inflation rate of 0 percent? Is the impact positive, negative, or unchanged? c. Assume that the cost of debt is fully indexed to the expected positive inflation rate so that the NPV of the loan and loan repayment, discounted by the cost of debt, is zero. What is the present value of the interest payments in the presence of inflation, relative to the case where the expected inflation rate is zero? Is it higher,lower or unchanged? What is the impact of inflation on the tax savings from the interest deduction?
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