6.Reynolds has been provided with the information contained in Tables 1 and 2 below, where the estimated value of the emerging market firm is presented based on a five-year cash flow forecast.

Table 1: Real Valuation of Emerging Market Firm

Table 2: Nominal Valuation of Emerging Market Firm

Note in Table 2 that the expected inflation rate is 35% in year-1 and 15% in years 2 through 5. Which of the following most accurately reflects the effect of an increase in inflation to 35% over years 2 through 5 on firm value in both real and nominal term?

B)   no change                          increases by at least 323

C)   no change                          no change

D)   decreases by at least 323   decreases by at least 323

7.Wavington Enterprises is headquartered in an emerging market nation that is expected to have 27 percent inflation over the next year. Charleston Johnson expects the local government to be successful in bringing inflation under control, and anticipates that it will fall to 20 percent in the second year and 10 percent in the third year, where he expects inflation to stabilize. Johnson asserts that the financial ratios of Wavington will be the same in both the real and nominal approaches. With regard to this statement, Johnson is:

A)   correct because the underlying operations of the firm are unaffected by valuation methodology.

B)   correct because the rate of inflation used in calculating the components of financial ratios is the same for all components.

C)   incorrect because cash flow forecasts in real terms are generally more accurate than cash flow forecasts in nominal terms.

D)   incorrect because cash flow forecasts in nominal terms are generally more accurate than cash flow forecasts in real terms.

8.Wavington Enterprises is headquartered in an emerging market nation that is expected to have 27 percent inflation over the next year. Charleston Johnson expects the local government to be successful in bringing inflation under control, and anticipates that it will fall to 20 percent in the second year and 10 percent in the third year, where he expects inflation to stabilize. Johnson is considering an investment in Wavington, and has calculated the real weighted average cost of capital (WACC) for Wavington at 8 percent. Johnson states:
 

With respect to these two statements, Johnson is:

A)          Incorrect                             Correct

B)          Incorrect                                Incorrect

C)          Correct                                  Incorrect

D)          Correct                                  Correct

答案和详解如下：

6.Reynolds has been provided with the information contained in Tables 1 and 2 below, where the estimated value of the emerging market firm is presented based on a five-year cash flow forecast.

Table 1: Real Valuation of Emerging Market Firm

	Today	Year 1	Year 2	Year 3	Year 4	Year 5
Real FCF		117	152	155	158	162
Real continuing value						2,550
Total annual real cash flow		117	152	155	158	2,712
PV value factor (8%)		0.925926	0.857339	0.793832	0.73503	0.680583
PV of annual real cash flow		108	130	123	116	1846
Real firm value	2,323

Table 2: Nominal Valuation of Emerging Market Firm

	Today	Year 1	Year 2	Year 3	Year 4	Year 5
Nominal FCF		133	211	258	317	387
Nominal continuing value						6,155
Total annual nominal CF		134	211	259	318	6,542
Real WACC		0.08	0.08	0.08	0.08	0.08
E(Inflation)		0.35	0.15	0.15	0.15	0.15
Nominal WACC		0.458	0.242	0.242	0.242	0.242
PV factor		0.685871	0.552231	0.444631	0.357996	0.288241
PV of annual nominal CF		92	117	115	114	1,885
Nominal firm value	2,323

Note in Table 2 that the expected inflation rate is 35% in year-1 and 15% in years 2 through 5. Which of the following most accurately reflects the effect of an increase in inflation to 35% over years 2 through 5 on firm value in both real and nominal term?

Real Value

Nominal Value

A)   no change                          decreases by at least 323

B)   no change                          increases by at least 323

C)   no change                          no change

D)   decreases by at least 323   decreases by at least 323

The correct answer was D)

There is no need to go through the tedious and painful process of crunching through all the numbers to answer this question because firm value estimates should be the same regardless of whether they are based on real or nominal forecasts. Therefore, they should both change by the same amount when the inflation forecast changes, which means that A is the only possible choice.

While the question does not require you to know why this is the case, the following two reasons are offered to those of you who might be interested.

§ Depreciation in nominal terms increases by less than the increase in inflation, but nominal EBITDA increases by the increase in inflation, so EBITA and taxes in nominal terms increase.  That means real taxes increase, which leads to a decrease in real NOPLAT and free cash flow, causing value to decrease.

§ The investment in real working capital also increase when the inflation rate increase because the "holding period loss," increases.  This also reduces free cash flow therefore firm value.

7.Wavington Enterprises is headquartered in an emerging market nation that is expected to have 27 percent inflation over the next year. Charleston Johnson expects the local government to be successful in bringing inflation under control, and anticipates that it will fall to 20 percent in the second year and 10 percent in the third year, where he expects inflation to stabilize. Johnson asserts that the financial ratios of Wavington will be the same in both the real and nominal approaches. With regard to this statement, Johnson is:

A)   correct because the underlying operations of the firm are unaffected by valuation methodology.

B)   correct because the rate of inflation used in calculating the components of financial ratios is the same for all components.

C)   incorrect because cash flow forecasts in real terms are generally more accurate than cash flow forecasts in nominal terms.

D)   incorrect because cash flow forecasts in nominal terms are generally more accurate than cash flow forecasts in real terms.

The correct answer was C)

In general, the ratios based on cash flow forecasts in real terms are accurate while ratios based on nominal forecasts are incorrectly estimated.

8.Wavington Enterprises is headquartered in an emerging market nation that is expected to have 27 percent inflation over the next year. Charleston Johnson expects the local government to be successful in bringing inflation under control, and anticipates that it will fall to 20 percent in the second year and 10 percent in the third year, where he expects inflation to stabilize. Johnson is considering an investment in Wavington, and has calculated the real weighted average cost of capital (WACC) for Wavington at 8 percent. Johnson states:
 

Statement 1:	The nominal WACC for Wavington next year is 35 percent.
Statement 2:	The firm value will be approximately the same using either the real or nominal approach to valuation.

With respect to these two statements, Johnson is:

Statement 1

Statement 2

A)          Incorrect                                Correct

B)          Incorrect                                Incorrect

C)          Correct                                  Incorrect

D)          Correct                                  Correct

The correct answer was A)

The nominal WACC for Wavington next year is ((1.27 x 1.08) – 1 =) 37.2%, not 35%. Johnson is incorrect regarding Statement 1. He is correct regarding Statement 2 that the nominal and real valuation approaches will produce approximately the same result.