Suppose if Mr. Harsh has been asked to suggest approaches that may be used while appraising the project under inflationary conditions. Explain these…

Under conditions of inflation, the project cost estimates that are relevant for a future date will suffer escalation. Inflationary conditions will tend to initiate the measurement of future cash flows. Either of the following two approaches may be used while appraising projects under such conditions: (1) Adjust each year's cash flows to an inflation index, recognizing selling price increases and cost increases annually; or (2) Adjust the 'Acceptance Rate' (cut-off) suitably retaining cash flow projections at current price levels. An example of approach (ii) above can be as follows: Normal Acceptance Rate: 15.0% Expected Annual Inflation: 5.0% Adjusted Discount Rate: 15.0 × 1.05 or 15.75% It must be noted that measurement of inflation has no standard approach nor is easy. This makes the job of appraisal a difficult one under such conditions.