It is imperative to discount nominal cash flows with a nominal rate in times of inflation to respect financial coherence and, above all, to capture the economic reality of differential inflations that affect the company.

Here are the detailed reasons based on your sources:

1. The distinction between “Macro” and “Micro” inflation.

The simplified theoretical approach sometimes suggests working in “real terms” (cash flows without inflation discounted with a real interest rate). However, this method is considered to be erroneous in practice because it implicitly assumes that the macroeconomic inflation rate (which influences the discount rate) is identical to the inflation rate experienced by the company on all its revenue and cost items.

However, the reality is that of differential inflation. There is not just one rate of inflation, but several:

• Macroeconomic inflation  (e.g. 4%) influences interest rates and therefore the nominal Weighted Average Cost of Capital (WACC).
• Microeconomic inflation affects cash flows in a heterogeneous way: selling prices can increase by 3%, while the cost of raw materials rises by 5% and the cost of energy explodes.

2. Modelling scissor effects

Using nominal flows makes it possible to explicitly model these deviations. If we were to work in real terms, we would mask the risk that unit costs will rise faster than selling prices, creating a margin squeeze. Calculating nominal flows requires forecasting the specific evolution of each item (wages, energy, materials).

3. The specific treatment of depreciation

Some accounting items are not subject to inflation. This is the case with depreciation, which is calculated on the historical acquisition value of the assets (historical cost).

• In times of inflation, depreciation remains constant in nominal terms (0% inflation), which means that its real value decreases.
• Since depreciation generates a tax saving (cash flow), not modeling the flows in nominal terms would distort the calculation of this tax benefit and, consequently, the value created.

In conclusion, to avoid management errors with serious consequences, the rule is to project nominal cash flows (incorporating inflations specific to each item) and to discount them with a nominal WACC (reflecting market return expectations including macroeconomic inflation).