Deck 22: Inflation

Question 1

What are the two indirect cash flow effects of inflation that depress value?

Answer 1

1.Companies suffer a loss on their depreciation tax shields if depreciation charges cannot be inflation-adjusted for tax purposes.2.Most companies cannot pass on to their customers the whole of any cost increases arising from inflation without losing sales volume.As a result,they fail to maintain profitability in real terms.

Question 2

Which of the following is NOT one of the steps in the five-step approach managers should employ to combine nominal and real forecasts?

A)Build financial statements in real terms.
B)Build financial statements in nominal terms.
C)Forecast operating performance in nominal terms.
D)Forecast the future free cash flows in real and nominal terms from the projected income statements and balance sheets.

Answer 2

C

Question 3

With respect to growth and operating margins,which is/are likely to be overstated in times of high inflation?

A)Growth only.
B)Operating margins only.
C)Both growth and operating margins.
D)Neither growth nor operating margins.

Answer 3

C

Question 4

Given the following information,compute free cash flow (FCF )in real terms: real growth is 3 percent,real ROIC is 12 percent,real NOPLAT is $5,000,real net working capital from the previous year is $2,000,the inflation index last year was 164,and the inflation index this year is 192.

A)$770.83
B)$2,958.33
C)$2,229.17
D)$3,458.33

Question 5

A firm begins with nominal net working capital NWCᴺt-₁ = 200 and then increases it to NWCᴺt = 250.The price index increases from IXt-₁ = 144 to IXt = 166.Based on this information,what is the real investment in NWC in year t?

A)9.51
B)10.84
C)30.12
D)49.73

Question 6

For which of the following is a nominal modeling application preferred to a real modeling application?

A)EBITDA.
B)Financial statements.
C)Investments in working capital.
D)Capital expenditures.

Question 7

An analyst should make financial projections of income statements and balance sheets for a valuation in a high-inflation environment by simply projecting all items on a nominal basis.

Question 8

Inflation is often persistent and difficult to fix,stretching out over several years as in the 1970s and 1980s,because suppressing it requires strict and unpopular government measures.

Question 9

If the nominal weighted average cost of capital (WACC )is 24 percent and inflation is 16 percent,then the real WACC is closest to:

A)7 percent.
B)8 percent.
C)13 percent.
D)15 percent.

Question 10

Which of the following are true about inflation?
I.It depresses market valuations.
II.Investors tend to correctly perceive inflation.
III.It does not affect the cost of capital in real terms.
IV.It can affect the real-terms cash flows generated by companies.

A)I and II only.
B)I and IV only.
C)II and III only.
D)III and IV only.

Question 11

Historical data shows that inflation leads to lower value creation in companies,because it erodes real-terms free cash flow (FCF )and increases the cost of capital.