inflation flow through through

SkipE99

Seen many contradictions on this:

If required return = 10%
inflation = 1%
flow through = 100%

is the P/E 10 or 11?

WarrenB1

You want to use the real required rate of return, so just subtract out inflation. they do the same thing in derivatives where they use the linear approximation for currency appreciation/depreciation instead of using the exact calculation.

Inflation in US 5%
Inflation in UK 2%

thus you expect UK to appreciate by 3% even though the exact calc is

[1+rDC/1+rFC] - 1= [1.05/1.03] -1 = 2.94%

economicz

My question is when given the nominal rate and inflation do we always adjust for inflation by subtracting (the approximation)? In this case it is close 9% vs 8.91%, but would it ever make a difference between two answer choices on the test?

neil1234

@KSTHANE nailed it.

Also notice the lower the flow through rate the lower the P/E

bdavi77962

How come sometimes we subtract inflation from nominal to get the real rate and sometimes we divide (1+ nominal) / (1 + inflation) = (1 + real)? Is subtracting just the approximation, if so would you ever get a question wrong for dividing?

bolligerallstar

P/E = 1 / (nominal - (inflation flow through rate) x (inflation ) )


OR


P/E = 1 / (real int + (1-inflation flow) x ( inflation))


if the question states real, then use the real.


peace

iteracom

The formula is

1/[(r-i)+(1-inflation flow through rate)*(inflation rate)]

So plugging the formula:

1/(.10-.01)+(0*.01)---->1/.09 = 11.11

lucasg85

Yep, r has to be real r. So if given nominal r, you must subtract inflation rate to get real r.

Rasec

This depends on your given required return. If it's real, P/E = 10. If it's nominal, P/E = 11.2*

OmarAdnan

Head in hands...



Edited 2 time(s). Last edit at Friday, May 27, 2011 at 05:45PM by Chuckrox8.