Free Cash Flow, I'm very much confused...

CFA Level II
#1

Can anyone explain why we must adjust for inflation in the following equations?

FCFt = (1-b)*NOPATt

FCFt = (1-greal/ROCreal)*NOPATt

b = retention ratio NOPAT = net operating profit after tax g = growth rate ROC = return on capital

#2

probably because you are using REAL growth rate and REAL return on capital. This way you will forecast REAL FCF. To derive nominal FCF, you need to adjust for inflation.

#3

As thinkwiseandact says. You need to adjust for inflation because you are using real variables.