[FredPret]

This one confused me as well when I learnt about it.

For valuing an investment, you have to take into account the inflation that will happen, as well as the opportunity cost.

So if you can earn 5% on your money, but inflation is 4%, you can turn $100 into $101 today-dollars in one year.

[chrismcb]

But why? If you don't invest then you turn the $100 into 96 today dollars. It seems to me that information is pretty much irrelevant.

[dpierce9]

Cost of capital includes an inflation term and the risk free rate (but neither may be right over the investment term).

You can use NPV to evaluate different options. If NPV of one investment is $1 and another is negative $4 then it is clear what the better investment is (all other things being equal). Do this for all your investment options and you can rank where to put your money. Of course, if isn’t that easy since two investments might have different terms, risk profiles, or different capital requirements.

[FredPret]

That's perfectly fine too. If you aren't going to invest the money, that's exactly what will happen. You use TVM - time-value-of-money - to compare multiple options of what to do with some money.

For an economist (and I'm not one so I don't know), they probably use the real growth rate of the economy in their calculations, because this is what the country in question has been shown to do with its money. The real growth rate takes growth and inflation into account.

[epolanski]

Well it is an important factor.

Average bond yield is around 4% over a decade, that means that investing in a business you need to discount the growth it will have in it's cash flow by 4%.

Imagine you conclude Coca Cola can grow it's cash flow and earnings per share by 6% annually, is it an appealing investment when you get right now almost 5 on bonds? I's not really, but you would probably come to a different conclusion if Coca Cola's price felt by 15% in some market conditions.

[tchaffee]

Not if you spend it instead of investing it.