What did the analyst from the Treasury Staff mean by his comment about inflation? Do you agree with it?

The analyst from the Treasury Staff commented that the inflation assumption used in Greystock’s DCF analysis was inconsistent with the historical data. Specifically, the analyst noted that the assumed inflation rate was lower than the average inflation rate over the past five years and that the cash flows in the analysis were expressed in nominal dollars, rather than real dollars.

This comment highlights the importance of using internally consistent assumptions when conducting financial analyses. Inflation is a significant factor that can impact the future cash flows of a project, and it is important to use realistic assumptions when forecasting future cash flows. Also, inflation can have a significant impact on cash flows over time, and failing to account for it correctly can lead to incorrect investment decisions. Therefore, it is important to use real, rather than nominal, cash flows in the DCF analysis and adjust the discount rate for inflation.

Morris should acknowledge the concern raised by the analyst and work with Greystock to adjust the inflation assumption in the DCF analysis to be consistent with historical data, as well as real cash flow data. She could also provide information about how the company plans to monitor and adjust the inflation assumption over time to ensure that it remains accurate.

How should Greystock modify his DCF analysis?

To make his DCF analysis more accurate, Greystock should adjust for the following:

• Include inflation in both the cash flows and discount rate.
• Remove the extraneous cash flows identified by the assistant plant manager.
• Use a more appropriate discount rate that accounts for the risks of the project.
• Incorporate the suggested $2 million expenditure to upgrade safety and environmental standards
• Account for cannibalization effects in the sales projections.

Additionally, he should provide a sensitivity analysis that shows the impact of changes in key assumptions on the project’s NPV, such as changes in the discount rate, inflation rate, and project timeline.

By making these adjustments, Greystock can produce a more reliable and accurate DCF analysis that provides a more accurate estimate of the project’s value.