Inflation is usually defined as the general rise in the price of the goods and services. So, it has huge impact over the Net Present Value analysis because we use nominal rate of return in discounting cash flows to the present value. Nominal rate of return is the rate which your investment yields without taking into accounts factor of inflation.

In order to take into account inflation rate, we need to calculate real rate of return RR. Usually, it is obtained by subtracting inflation rate from the nominal rate.

**Formula**

RR = { (1 + MR) / (1+ IR) }-1

Where:

RR = Real rate of return

MR = Nominal rate of return

IR = Inflation rate

**Example**

DCF is considering investing in a long term project of 05 years of $ 100,000 which will generate $ 25,000 each year. The nominal rate is 15 {1bb28fb76c3d282be6cfd0391ccf1d9529baae691cd895e2d45215811b51644c} and inflation rate is 10 {1bb28fb76c3d282be6cfd0391ccf1d9529baae691cd895e2d45215811b51644c}. Calculate the real rate of return.

**Solution**

As we know that:

RR = { (1 + MR) / (1+ IR) } – 1

RR = { (1 + 0.15) / (1 + 0.10) } – 1

RR = ( 1.15 / 1.10 ) – 1

**RR = 4.6 {1bb28fb76c3d282be6cfd0391ccf1d9529baae691cd895e2d45215811b51644c}**