Capital Investment Analysis: The Index Method
American Accounting Association
Issues in Accounting Education
Adjusting for Inflation in the analysis of capital Investments can be achieved by employing either nominal cash flows and discount rates, or real cash flows and discount rates. This paper introduces a third methodology that is consistent with both the nominal and real approaches, yet simplifies the procedure through the use of an Index that simultaneously adjusts for differential rates of inflation in the cash flows and general price levels. The index is the ratio of one plus the nominal required rate of return, divided by one plus the rate of inflation in a particular cash flow, and yields the appropriate discount rate for Implementation of the technique.