Nominal vs. Real

Wavington Enterprises is headquartered in an emerging market nation that is expected to have 27% 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% in the second year and 10% 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) incorrect because cash flow forecasts in real terms are generally more accurate than cash flow forecasts in nominal terms. B) correct because the underlying operations of the firm are unaffected by valuation methodology. C) correct because the rate of inflation used in calculating the components of financial ratios is the same for all components. D) incorrect because cash flow forecasts in nominal terms are generally more accurate than cash flow forecasts in real terms.

D or A



CFs are more accurate in real than in nominal




cfaboston28 Wrote: ------------------------------------------------------- > D or A nice editting… haha…

It’s A. I went for B… Schweser says that generally, ratios based on nominal forecasts are incorrectly estimated… I just went to the notes, and it makes sense… for instance, return on invested capital would be overstated in nominal terms and PPE to revenues would be understated…

Yeah, after I saw the A’s had rethought and had to agree, ah well natty, at least we went down together.

even i say it’s A. CFO = (S-C-D)*(1-TR) + D the S and C would increase like 27%, let’s say, but the D is based on the asset’s original value (when it was MUCH MUCH CHEAPER), and the D is proportionately LESS LESS LESS. However, when INF=0, then we see that the CFO is a much more informative.

I’m just going to call it a night, and get ready for practice exam tomorrow. Everyone, best of luck studying!