Financial Projections in Real and Nominal Terms  501
To prepare consistent financial projections, you therefore need to use 
elements of both nominal and real forecasts. This section illustrates how to 
combine the two approaches in a DCF valuation. The example considers a 
company whose revenues grow at 2 percent in real terms while the annual 
inflation rate is 20 percent in the first forecast year and 10 percent thereafter 
(see Exhibit 26.6). To simplify, we assume that all cash flows occur at the end 
of the year.11
In practice, financial projections for high-inflation valuations raise many 
more issues than in this simplified example. Nevertheless, the example is use-
ful for showing how to address some key issues when developing a cash flow 
forecast in periods of inflation. Using the following step-by-step approach 
leads to the real and nominal valuation results shown in Exhibit 26.7.
Step 1: Forecast Operating Performance in Real Terms
To the extent possible, convert historical nominal balance sheets and income 
statements into real terms (usually at the current year’s currency value). 
At a minimum, make a real-terms approximation of the historical develop-
ment of the key value drivers—growth and return on capital—and the un-
derlying capital turnover and EBITA margin, so you can understand the true 
11 At extremely high, fluctuating levels of inflation, however, this assumption could distort financial 
projections, because the cash flows that accumulate throughout the year are subject to different inflation 
rates. In such cases, split the year into quarterly or even monthly intervals, project cash flows for each 
interval, and discount the cash flows at the appropriate discount rate for that interval.
EXHIBIT 26.6  DCF under Inflation: Operational and Financial Assumptions
Forecasts
Year 1
Year 2
Year 3
Year 4
Year 5
…
Year 25
Operational assumptions
Real growth rate, %
2
2
2
2
…
2
Real revenues, $
1,000
1,020
1,040
1,061
1,082
…
1,608
Real EBITDA, $
300
306
312
318
325
…
483
Net working capital/revenues, %
20
20
20
20
…
20
Real net PP&E/real revenues, %
40
40
40
40
…
40
Lifetime of net PP&E, years
5
Financial assumptions
Inflation rate, %
20
10
10
10
…
10
Inflation index
1.00
1.20
1.32
1.45
1.60
…
10.75
Tax rate, %
35
35
35
35
…
35
Real WACC, %
8
8
8
8
…
8
Nominal WACC, %
29.6
18.8
18.8
18.8
…
18.8

EXHIBIT 26.7  DCF under Inflation: Real and Nominal Models
Nominal projections
Real projections
Year 1
Year 2
Year 3
Year 4
Year 5
…
Year 25
Year 1
Year 2
Year 3
Year 4
Year 5
…
Year 25
NOPAT, $ million
Revenues
1,000
1,224
1,373
1,541
1,729
…
17,283
1,000
1,020
1,040
1,061
1,082
…
1,608
EBITDA
300
367
412
462
519
…
5,185
300
306
312
318
325
…
483
Depreciation
(80)
(80)
(85)
(92)
(100) …
(926)
(80)
(80)
(82)
(83)
(85)
…
(126)
EBIT
220
287
327
370
419
…
4,259
220
226
231
235
240
…
356
Taxes
(77)
(101)
(114)
(130)
(147) …
(1,491)
(77)
(84)
(87)
(89)
(92)
…
(139)
NOPAT1
143
187
212
241
272
…
2,768
143
142
144
146
148
…
218
Free cash flow, $ million
NOPAT
143
187
212
241
272
…
2,768
143
142
144
146
148
…
218
Depreciation
80
80
85
92
100
…
926
80
80
82
83
85
…
126
Capital expenditures
(80)
(106)
(118)
(133)
(149) …
(1,491)
(80)
(88)
(90)
(92)
(93)
…
(139)
Investment in net working capital
(45)
(30)
(34)
(38) …
(376)
(37)
(23)
(23)
(24)
…
(35)
Free cash flow
116
149
166
185
…
1,827
97
113
114
116
…
170
Invested capital, $ million
Net PP&E (beginning of year)
400
400
426
459
500
…
4,631
400
400
408
416
424
…
631
Depreciation
(80)
(80)
(85)
(92)
(100) …
(926)
(80)
(80)
(82)
(83)
(85)
…
(126)
Capital expenditures
80
106
118
133
149
…
1,491
80
88
90
92
93
…
139
Net PP&E (end of year)
400
426
459
500
549
…
5,196
400
408
416
424
433
…
643
Net working capital
200
245
275
308
346
…
3,457
200
204
208
212
216
…
322
Invested Capital
600
670
734
808
895
…
8,653
600
612
624
637
649
…
965
Ratios, %
Net PP&E/revenues
35
33
32
32
…
30
40
40
40
40
…
40
Net working capital/revenues
20
20
20
20
…
20
20
20
20
20
…
20
ROIC
31
32
33
34
…
36
24
24
23
23
…
23
FCF growth rate
28
11
12
…
12
17
1
1
…
2
DCF valuation, $ million
Free cash flow
116
149
166
185
…
1,827
97
113
114
116
…
170
Continuing value (Value driver formula)2
31,063
2,891
Continuing value (Cash flow perpetuity formula)
31,064
2,891
Present value factor
0.77
0.65
0.55
0.46
…
0.01
0.93
0.86
0.79
0.74
…
0.16
DCF value, $ million
1,795
1,795
1 Net operating profit after taxes.
2 Adjusted formula for real-terms continuing value.
502