DEPARTMENT OF BANKING AND

FINANCE
ABDU GUSAU POLYTECHNIC TALATA MAFARA ZAMFARA

HNDII BANKING AND FINANCE

ASSIGNMENT ON:
INVESTMENT AND PORTFOLIO MANAGEMENT

QUESTION
a. Define this term inflation and distinguish between money and cash flow and
real flow
b. Calculate money and real discount rate
c. Analyze the impact of inflation on investment decision and explain the
treatment of inflation and taxation in capital budgeting decision

NAME: FOLORUNSHO AFOLABI

REG NO: 2001921019

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Introduction
Inflation is a general and ongoing rise in the level of prices in an entire economy. Inflation does
not refer to a change in relative prices. A relative price change occurs when you see that the price
of tuition has risen, but the price of laptops has fallen. Inflation, on the other hand, means that
there is pressure for prices to rise in most markets in the economy. In addition, price increases in
the supply-and-demand model were one-time events, representing a shift from a previous
equilibrium to a new one. Inflation implies an ongoing rise in prices. If inflation happened for
one year and then stopped—well, then it would not be inflation any more.
What is inflation?
Inflation is an increase in the level of prices of the goods and services that households buy. It is
measured as the rate of change of those prices. Typically, prices rise over time, but prices can
also fall (a situation called deflation).

Inflation is a general increase in the prices of goods and services in an economy. When
the general price level rises, each unit of currency buys fewer goods and services; consequently,
inflation corresponds to a reduction in the purchasing power of money. The opposite of inflation
is deflation, a sustained decrease in the general price level of goods and services.

DIFFERENCE BETWEEN MONEY AND CASH FLOW AND REAL FLOW

 Money income of a country is the amount of income (in monetary terms) earned by
factors of production excluding transfer payment in a given year or how of goods and
services produced in an economy.
However, money, as a medium of exchange, and a measuring device, has one major
disadvantage. This is the change in its size from time to time due to inflation in the
system. Hence, there is a difference between money income and real income.

 Cash flow The term cash to most people refers to physical bills and coins. In consumer
transactions cash also refers to the physical bills and coins, better known as currency. But
the reality in economics is a bit different. Cash in economics is a form of liquid asset that
is listed on a company's balance sheet. Cash is essentially the money a company has that
can immediately be spent. Cash includes coins, bills, bank balances, money orders,
cashier checks and personal checks. So technically when a consumer swipes their debt
card at the store, they are using cash, since it comes from their bank account

 Real Income is the basket of goods and services which the money income can obtain.
1. In terms of the National Income, real national income is obtained by dividing the
money national income by the price index
2. Money flows depict the way that money and credit circulate in the economy as income
turns into savings and investment and back again.
3. Real flows depict the way that commodities and products & services are produced and
consumed in the economy.

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CALCULATE MONEY AND DISCOUNT RATE
This discount calculator allows you to find the reduced price of a product and the amount of
money you save. You can also use it for the reverse and calculate the size of the discount or the
original price. As a shopper, you it also functions as a sale price calculator to help you negotiate
the price.

MONEY
Money, a commodity accepted by general consent as a medium of economic exchange. It is the
medium in which prices and values are expressed; as currency, it circulates anonymously from
person to person and country to country, thus facilitating trade, and it is the principal measure of
wealth.
REAL DISCOUNT RATE
Discount Rate?

The discount rate refers to the rate of interest that is applied to future cash flows of an investment
to calculate its present value. It is the rate of return that companies or investors expect on their
investment. An investment’s net present value computed through discounting reveals its
viability.

Depending upon the context, the discount rate has two distinct definitions and usages.

 The discount rate is the interest rate charged to commercial banks and other financial
institutions for short-term loans they take from the Federal Reserve Bank.
 The discount rate refers to the interest rate used in discounted cash flow (DCF) analysis
to determine the present value of future cash flows. 

Discount formula

The formula for discount is exactly the same as the percentage decrease formula:

discounted_price = original_price - (original_price * discount / 100)

How to calculate discount and sale price?

1. Find the original price (for example $90)

2. Get the the discount percentage (for example 20%)
3. Calculate the savings: 20% of $90 = $18
4. Subtract the savings from the original price to get the sale price: $90 - $18 = $72
5. You're all set!

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IMPACT OF INFLATION ON INVESTMENT DECISIONS.

Prices do not remain constant over a period of time. They tend to change due to various
economic, social or political factors. Changes in the price levels cause two types of economic
conditions, inflation and deflation. Inflation may be defined as a period of general increase in the
prices of factors of production whereas deflation means fall in the general price level.

CAPITAL BUDGETING AND THE TREATMENT OF INFLATION

1. Forecasts Spread Over a Period of Time

Inflation is an ever persistent condition in today’s economy. The purchasing power of money has
been reducing year after year for decades now. Apart from the occasional recession where
money may gain real value, the usual case is a loss of value. Investors are investing money
today. They want to be compensated for the inflation and still get a return over and above it. This
simply means that they want to gain value in real terms.

It is important for us to understand this while coming up with our cash flow estimations. This is
because projects never give all of their cash flows in the same period. Cash flows from projects
are usually spread out over many years, even decades. The treatment of inflation therefore
becomes very important to come up with the correct value. Minor changes in the assumptions
about inflation are capable of producing massive changes in the expected return from the project.
A viable project may become unviable simply by tweaking the inflation numbers a little bit. This
article will explain how inflation needs to be treated while performing these calculations:

2. Inflation Affects Different Components Differently

First, we need to understand that inflation never affects all the components of the income
statement uniformly. Therefore assuming a uniform rate for all the components might give
theoretically correct answers, but in practical life it will be a blunder. For instance, consider the
fact that labor costs will go up every year. Employees usually expect to be paid a hike every
year. Also, the cost of raw materials is expected to go up every year. Tax rates change every
year. However, the increase in sales price cannot match these changes. It will usually be either
more or less than the percentage change in other components. Sales price is market driven and
we can’t just raise it without incurring any loss.

3. The Golden Rule

The golden rule when it comes to capital budgeting and inflation is that we must be consistent in
our treatments of inflation. The keyword is consistency. If we have real cash-flows, we must
discount them at the real rate of interest. On the other hand, if we have nominal cash flows
(usually the case), we must discount them at a nominal rate of interest. This might seem obvious,
but is a common mistake to use the wrong discount rate.

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INCOME TAX AND CAPITAL BUDGETING DECISIONS:

1. Include income taxes in a capital budgeting analysis.

In our discussion of capital budgeting decisions in this chapter, we ignored income taxes for
two reasons. First, many organizations do not pay income taxes. Not-for-profit organizations,
such as hospitals and charitable foundations, and government agencies are exempt from income
taxes. Second, capital budgeting is complex and is best absorbed in small doses.

The US income tax code is enormously complex. We only scratch the surface on this page. To
keep the subject within reasonable bounds, we have made many simplifying assumptions about
the tax code throughout this section. Among the most important of these assumptions are :

1. Taxable income equals net income as computed for financial reports.

2. The tax rate is flat percentage of taxable income. The actual tax code is for more complex
than this; indeed, experts acknowledge that no one person knows or can know it all.
However, the simplifications that we make throughout this section allow us to cover the
most important implications of income taxes for capital budgeting without getting bogged
down in details

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REFERENCE
Abaidoo, R. (2015). Inflation, Inflation Expectations and Investment Performance Volatility:
Evaluating Potential
Causal Interactions. International Journal of Economics and Finance, 7(5), 50-60.
Abel, A. B. (1983). Optimal investment under uncertainty. The American Economic Review,
73(1), 228-233.
Abel, A. B. (1990). Consumption and investment. Handbook of Monetary economics, 2, 725-
778.
https://doi.org/10.1016/S1573-4498(05)80021-9.
Baldwin, C. Y., & Ruback, R. S. (1986). Inflation, uncertainty, and investment. The Journal of
Finance, 41(3),
657-668. https://doi.org/10.1111/j.1540-6261.1986.tb04528 .x
Ball, L. (1992). Why does high inflation raise inflation uncertainty? Journal of Monetary
Economics 29(3), 371-
388. https://doi.org/10.1016/0304-3932(92)90032-W