Is it advisable to reflect inflation in FCF projections?

In discounted cash flow (DCF) analysis, correctly projecting future cash flows is essential for obtaining an accurate enterprise value. Including inflation in free cash flow (FCF) projections is advisable because it reflects the reality of how costs and revenues will increase over time due to inflationary pressures on the economy. This approach helps in aligning the projections with nominal cash flow generation, which is how businesses often assess performance and make financial decisions.

By incorporating inflation into FCF projections, you ensure that the cash flows are representative of the future environment in which the business operates. Revenues and costs are both affected by inflation, and neglecting to account for it could lead to underestimated expenses or overestimated net income, skewing the overall valuation.

Hence, it is crucial to consider inflation for accurate cash flow predictions that reflect the true economic situation. Models that consider inflation allow for a more precise and realistic assessment when valuing a company, thereby leading to better investment decisions.