What is the difference between nominal and real cash flow in DCF?

Nominal cash flow refers to the amount of money that is projected to be received in the future without any adjustments for inflation. This means that the nominal cash flow will reflect the actual dollar amounts expected at that time. On the other hand, real cash flow accounts for the effects of inflation, providing a more accurate representation of purchasing power over time. When calculating the present value in a discounted cash flow (DCF) analysis, it's essential to understand this distinction because using nominal cash flows with a nominal discount rate generally gives a clearer picture of future cash positions in today's terms.

When using real cash flows, you essentially strip away the inflationary effects, focusing instead on the true value of money over time, which is particularly valuable for long-term projections. This approach helps businesses and investors make better decisions regarding investments, as it reflects the actual growth in purchasing power.

Thus, the correct understanding is that nominal cash flows do not account for inflation, while real cash flows do.