Investment Decisions and Inflation

K. Garoufalis

Abstract


The present article reports on a study of investment appraisal techniques giving particular emphasis to the treatment of inflation. It is well known that several practicing managers usually estimate the results of proposed investment projects in terms of current prices and they completely ignore the effect of inflation. An investment normally involves a cash outlay followed by the receipt of cash benefits and inflation increases current prices by an amount that becomes larger with the passage of time. It seems possible that methods of dealing with inflation in project appraisal represent one set of factors which contribute to under-investment. It should be noted, that the bias from the neglect of inflation is likely to be higher, the higher the expected rate of inflation. We will show that the treatment of inflation in the appraisal process does no more than ensure the rejection of risky projects, in other words it acts as a proxy allowance for a factor, named risk.


Keywords


Risk, inflation, investment appraisal, cost, return.

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References


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