To discount a cash flow I am told to use interest rate plus credit risk if the cash flow has a credit risk. Why do I not include inflation in the calculation? in 2022 rates went high because the FED was hiking rates and not because the inflation was high. But the value with my 30 year cash flow gets smaller and smaller with inflation prevailing. Why is it not inflation in the discounting: $$DF=1/(1+r_{\text{free}})\times 1/(1+\text{credit spread})\times 1/(1+\text{inflation rate})$$
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1$\begingroup$ The general rule: you discount nominal amounts with nominal interest rates, you discount inflation-adjusted (real) amounts with real interest rates (See for ex. should you use real or nominal discount rates cals.arizona.edu/classes/rnr485/ch4.htm). So if you are working with nominal cash flows (as is usually the case, both in textbooks and in reality), you are correct to discount with nominal interest rates. $\endgroup$– nbbo2Mar 30 at 12:01
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The reason you do not have to discount for the inflation rate, is that the risk free rate is set, in part, by the inflation rate. That is, during times of high inflation you would expect the risk free rate of money to be high.
The risk free interest rate is normally specified per year. As such, you may need to adjust your formula for DF.
