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Valuation: Measuring and Managing the Value of Companies, Sixth Edition
Chapter 22 Inflation
Solutions
1. Inflation typically destroys firm value because 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
2. The ROIC would initially go up more for the firm with long-lived assets, because the returns will
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 margins for periods
4. For the assets currently on the books, the depreciation tax shields will decline in value. This decline
5. Real forecasts are important to have because they can be adjusted for changes in inflation forecasts;
however, the nominal forecasts produce the actual cash flow measures needed for decision making.
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 statements from the
7. The reason ROIC needs to increase more than inflation is that invested capital and depreciation do
8. LIFO provides a better estimate of costs during periods of inflation and deflation. However, if the
