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LOS a: Describe how inflation affects the estimation of cash flows for a company domiciled in an emerging market.

In order to properly measure the cash flows of an emerging market company to consider the impact of inflation, one starts the process by constructing the:

A)	historical financial statements using the temporal method.

B)	forecasted financial statements using the current method.

C)	historical and forecasted financial statements in both nominal and real terms.

Construct historical and forecasted financial statements in both nominal and real terms. Historical financial statements are translated to real terms by using the current method. Forecasted financial statements in real terms are then created and then converted to nominal terms. Finally, calculate the nominal cash flows and convert them to real terms.

With respect to emerging market companies, which of the following macroeconomic variables has the most impact on the estimation of cash flows?

Emerging markets are characterized by high inflation. Inflation affects the financial statements by creating distortions in non-monetary assets (i.e. property, plant, equipment and inventories). Cash flow projections used in valuations, as well as most financial ratios, will also be distorted.

When valuing an emerging market company using cash flows expressed in both nominal and real terms:

A)	both valuations are identical.

B)	both valuations are not reliable.

C)	each valuation differs by the inflation differential.

In order to adjust for the influences of inflation, company cash flows will require restatement in both nominal and real terms. Construct historical and forecasted financial statements in both nominal and real terms. Calculate the nominal cash flows and convert them to real terms. Discount the nominal and real cash flows to determine their respective valuations for both terms. The valuations under both terms should be identical.

An analyst is calculating ratios from nominal financial statements. The company is domiciled in an emerging market with high inflation. Which of the following effects is least likely?

A)	Solvency ratios, such as debt to assets, will be too low.

B)	Fixed asset turnover will be overstated.

C)	Operating margins will be overstated.

Solvency ratios, such as debt to assets, will be too high as assets are understated. Fixed asset turnover will be overstated because fixed assets do not capture inflation effects in a timely manner, but sales do reflect the effect of inflation. Operating margins will be overstated as sales reflect inflation but depreciation does not.