Valuation: Measuring and Managing the Value of Companies, Fifth Edition
Chapter 29 Solutions
Inflation
1. The general reasons are that the firm cannot pass on inflation in full to its customers, and
the cost of capital increases more than the free cash flow. One way to look at the situation
2. The ROIC would initially go up more for the firm with long-lived assets because the
returns will increase with inflation while the book value of invested capital will not
3. High inflation introduces many distortions. Depreciation and the replacement costs of
assets on the balance sheet are understated. On the income statement, the sales and profit
4. For the assets currently on the books, the depreciation tax shields will decline in value.
This decline occurs because they are determined by the initial investment and the
5. Real forecasts are important to have because they can be adjusted for changes in inflation
6. The five steps are (1) forecast real operating performance by converting historical
financial statements to real terms and projecting forward, (2) derive forecasted nominal
7. The reason ROIC needs to increase more than inflation is that invested capital and
8. The problem with a high-inflation environment in this case is that the stock of current
inventory will not reflect its replacement value. In the following scenario, the firm buys
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9. LIFO provides a better estimate of costs during periods of inflation and deflation.
However, if the inflation is very high, LIFO may still underestimate replacement costs.
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