Assigned Reading #39: Valuation in Emerging Markets - LOS 39 index, required, capital, someone

thecfawannabe

“Income taxes are based on nominal earnings, so a forecast of nominal earnings before taxes is required. ” Thus, one cannot simpy calculate real taxes on the basis of real EBITA.
“The real cash flow from working capital is not equal to the change in real working capital, so nominal working capital cash flows must be converted to real cash flows using the inflation index.”
Can someone please explain to me why these two things are the case? They seem counterintuitive.
Many thanks.

redskins44

Just to add to cpk’s post on the 1st point:
Let’s say you make $100k a year and pay $30k in taxes. 1 year later, you make the same salary but inflation goes up 50%. You will still pay the same in amount in taxes, regardless of what happens to the price level. What you can do, however, is take the nominal level of earnings and deflate it by a CPI index or something similar.

krause2

In forecasting NWC.
1. Nominal NWC = % of Nominal Revenue
2. Nominal investment in NWC = Change in Nominal NWC
3. Real NWC = % of real Revenue
4. Real investment in NWC= Nominal investment in NWC discounted with inflation index.
Common mistake is to do Real investment in NWC = Change in Real NWC.
Real investment in NWC is higher since it must in addition compensate for loss of real spending power of existing NWC (compared to last year)