Check whether an investment model mixes real and nominal cash flows

A future cash amount can be expressed in the purchasing power of a base date or in the money expected to be paid at the future date. Ask the model owner which basis each forecast uses. A supplier quote dated today, a future contracted payment and an inflated planning estimate should not be combined without identifying their price dates.

ACCA's investment-appraisal guidance pairs nominal cash flows with a nominal discount rate and real cash flows with a real rate. The practical check is consistency. Do not assume the model follows one basis merely because a worksheet or presentation uses the word real.

For a simplified hypothetical example, take a base-price amount of $100,000 payable one year later. Assume general inflation of 3% and a nominal discount rate of 8%. The nominal amount is $103,000, and its present value is approximately $95,370 when divided by 1.08.

The corresponding real rate is 1.08 divided by 1.03, minus one, or approximately 4.8544%. Discounting the $100,000 real amount at that rate produces the same present value, subject to rounding. The rates are illustrative inputs, not a forecast or a recommendation for your company's cost of capital.

Review the assumptions applied to selling prices, wages, materials and other inputs. A contract with a fixed amount differs from a cost expected to rise at a specified rate. Record the evidence and owner for each assumption. Applying the same uplift to every line can conceal a real change in margin when costs and selling prices move differently.

Check the timing of the first increase and whether later increases compound. An annual escalation beginning after twelve months should not automatically inflate the first month's payment. Where a contract uses an index or cap, obtain the actual clause and have the appropriate reviewer explain its application. The spreadsheet should implement that interpretation transparently.

Examine the model's source data for inflation already included. A future-price quote should not receive the same uplift again merely because it enters a general forecast-input sheet. Add a clear basis field or supporting note so the next person updating the model can distinguish an unadjusted amount from a future contractual price.

Ask the adviser to identify the effect of any inconsistency on the decision outputs. Show the corrected case alongside the prior version and explain whether the preferred option changes. A corrected formula is easier to assess when management can see its effect on value, required funding and key assumptions.

This check does not determine the appropriate discount rate, tax treatment or accounting measurement for a particular transaction. Assign those judgments to the relevant financial and accounting specialists. A financial-reporting valuation may have requirements beyond an internal investment comparison, even when both use discounted amounts.

Retain the price basis, inflation assumptions, rate assessment and review version with the approved model. Include a simple reconciliation like the one above in the checking process where relevant. The objective is an understandable calculation whose inputs use compatible meanings, so a later update does not silently reintroduce the mismatch.