The discount rate does need to be increased, because the firm will require a higher rate of return to compensate for the increased inflation. However, this is not the only adjustment that is necessary to determine net present value in an inflationary environment.
The estimated future cash inflows need to be increased, not decreased, to reflect the lower value of the dollar in the future as a result of the inflation.
The estimated future cash inflows do need to be increased, to reflect the lower value of the dollar in the future as a result of the inflation. However, the discount rate also needs to be increased, because the firm will require a higher rate of return to compensate for the increased inflation.
In an environment of inflation, both the discount rate used and the future expected cash flows should be increased. The discount rate is increased because the firm will require a higher rate of return to compensate for the increased inflation. The future expected cash flow amounts need to be increased because inflation will cause the dollar to be worth less in the future, and the amounts of cash (both inflows and outflows) will therefore increase in the future.
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