Inflation and Project Evaluation: A Case Study of the Effect of Price Changes on Rate of Return

Inflation is one important economic variable which is playing an ever-expanding role in the decision making process of business, industry and government. The evaluation of capital expenditure projects are based on estimation of future economic benefits from such expenditure, and if such benefits are susceptible to changing prices, it becomes necessary to measure such effects. The major thrust of this study is that the discounted cash flow rate of return measure used in making capital investment is sensitive to prive-level changes. Several factors constitute the determinants of the resulting effects of price-level changes on rate of return. We have to separate the responsiveness of operating expenses from revenue, it is wholly conceivable that two are not equally responsive to general price-level changes. In this study, we used the empirical data as opposed to a hypothetical example to gauge the sensitivity of Internal Rate of Return to price-level changes.