What is the purpose of adjusting future cash flows for inflation during DCF analysis?

Adjusting future cash flows for inflation during DCF analysis is essential to ensure that the cash flow estimates reflect real purchasing power. Inflation erodes the value of money over time, meaning that a dollar received in the future will not have the same purchasing power as a dollar received today. By adjusting for inflation, analysts can convert nominal cash flows (which may not account for this erosion) into real cash flows that accurately represent what those amounts would be worth in today's terms. This provides a more accurate picture of a project's profitability and financial viability, as it aligns the cash flows with the economic reality faced by consumers and businesses.

This approach helps in making investment decisions based on the true economic benefits and costs associated with the future cash flows generated by a project or asset.