Just a quick question regarding inflation in valuating emerging markets. The book mentioned that emerging econ typically experiences high inflation therefore on the balance sheet inventory, plant, proper, etc may be shown at values well below their current cost. Also solvency ratios would be too high since assets are understated. Can someone please explain those two items for me ? Thank You
PP&E sits on the B/S at its cost. Therefore, in an inflationary environment (rising prices), sales will be reported based on its current prices (includes effects of inflation) while PP&E (assets) will be at reported at the cost (less depreciation). This will make ROA and asset turnover overstated. Solvency ratio such as Debt/Assets will be overstated since assets in the denominator is less than the current market value.
good explanation gangsta
I am struggling with this, you say assets in the denominator (Debt/Assets) would be lower (worth less than market) but so would debt Isnt LTD recorded at amortized cost (add discount/less premium) so wont Debt also be understated so how can you be sure that Debt/Assets will be understated In fact your NOPLAT is higher which will make Retained Earnings and hence Equity higher so wont D/E be understated?
ah good argument, i don’t know the right answer sorry. My inclination is that debt/equity is understated with inflation because the debt value goes down too so that we owe back less (what all governments want to do)
D/A should be lower because D is included in A. In other words, A is bigger than D so that means A is MORE understated than D is, so D/A overall is higher than it should be.