Section 9 ASM edition 11 #1

This is a pretty trivial problem but I don't understand the convention being used here.



The real rate of interest is 4%. Expected annual inflation rate over the next two years is 5%. What is the net present value of the following cash flows



year...........0............1............2

cash flow...-300.......160........160



My first thought was "great, we know the interest rate, we know the rate of inflation, we can find the real rate of return using 1+i'=(1+i)/(1+r) and discount the cash flows back to time zero, piece of cake."



And then I realized that the 4% IS the real rate of return. So I figured we'd just let v=(1.04)^-1, discount each cash flow and be done.



But the solution uses that (1+real rate)(1+inflation rate)=(1+market rate), from which we find that the market rate is .092. They then let v=(1.092)^-1 and proceed as one would expect.



What I don't understand is why we go through the process of, so to speak, "unaccounting" for inflation to arrive at the correct answer. Why would we not use the real rate of return?

Section 9 ASM edition 11 #1