Discussion 10: Analyzing Project Cash Flows

Effects of Inflation on Project Cash Flows Name Institutional affiliation Effects of Inflation on Project Cash Flows Inflation refers to the increase in prices, leading to a reduced value of money. Prices may either due to higher demand or higher cost of producing goods and services. For instance, a sharp increase in the cost of crude oil causes an increase in the cost of production therefore businesses increase the prices to cover the additional costs. Inflation may impact the project cash flow in three ways borrowed capital, return on investment and the working capital. The business takes a loan from the bank or other lenders to finance its projects. When the interest rate is fixed and value of money reduces, the business pays less money than it borrowed. However, inflation increases the demand for credit, therefore forcing the interest rates high. If inflation kicks in before the business takes the loan, the business would have to incur higher cost of borrowing than earlier planned. Inflation may reduce the return on investment. During planning, the business estimates the return on investment of the project. The financial projection can only be realised if inflation remains constant. However, if the company estimated a