guys, i am able to keep in mind the relationship between inflation and tax shield/real taxes and real interest rates…but the intution behind it is not too strong for me… any explanation, analogy, intuitive intuition?..
For the first one - Depreciation is based off your book values which are on the low side due to inflation (you have both your PP&E when they cost less in nominal terms). So depreciation is low = depreciation * tax is low = low tax shield on depreciation. Since we have (1+Inflation)(1+real interest rate) = (1+nominal interest rate), real interest rates will always be reduced by inflation… was that what the second part of your question was? If it isn’t can you repeat what the relationship here was supposed to be?
i think you got it spot on take a look at cfai text corp fin page 78 question 9, and share your thoughts…
Got it - the question is on (a) real tax savings and (b) real interest expense when inflation is lower than expected (the “reduce” part actually tripped me up when I looked at the question just now) (a) The opposite of above (now that inflation is reducing) - the tax shield is NOT reduced. (b) Since we issued bonds at a nominal interest rate, assuming an inflation of I, when I happens to be less than what we expected, we are paying a bit more than what we should have paid if the correct inflation figure was known. Real interest expense is high.