Real/Nominal Interest/Discount Rates

Real Interest/Discount Rates do not include inflation .
Nominal Interest/Discount Rates do include inflation .
Inflation Rate is an increase in price levels, expressed as an annual rate. Inflation erodes the purchasing power of income and investments. In the U.S., inflation is usually measured by producer price index (PPI), and consumer price index (CPI), . The PPI measures inflation for the producer goods such as machinery. The CPI measures inflation for the consumer goods such as food and clothes. From 1931 to 2001 in the U.S., the average annual CPI increased about 4.15%.

One should usually use real discount rates in timberland investment analyses or any other investment analyses. If nominal discount rates are used, one should also apply inflation rates to all the costs and revenues in the analyses. Because the inflation rates are very hard to forecast, using real discount rates simplify the analyses. If both nominal discount rates and the corresponding inflation rates are used in an analyses, the results will be the same to using real discount rates only.


The relationship between real rate and nominal rate is (Fisher formula):
Rn = (1 + Rr)(1 + Ri) - 1 = Rr+ Ri+ RrRi
Where, Rn is nominal rate, Rr is real rate and Ri is inflation rate.