was there a ? about inflation effect on corp finance vignette?

…something about real tax cost and real CF if inflation higher than expected. This just popped in my head- I may be pulling it out of my arse…

I put decrease for both…it was taxes and interest payments right?

If inflation higher than expected, - real saving from depreciation should decrease. Because depreciation is based on nominal figure, so the yearly nominal tax saving from depreciation is the same no matter how high is the inflation. Under a higher inflation, the real saving is lower. - assume “inflation higher than expected” mean sales amount and operating cost inflated at a higher rate. At first glance, it should have no effect on real cash flow. However, the nominal saving from depreciation claim doesn’t inflate, so the real saving from depreciation decrease, therefore the real CF decrease.

ConfusedbyCFA Wrote: ------------------------------------------------------- > I put decrease for both…it was taxes and interest > payments right? absolutely CORRECT

I think that tax savings would decrease- real interest payments to corp increase. Should be right out of the CFA texts on this one…

DBmorgan Wrote: ------------------------------------------------------- > I think that tax savings would decrease- real > interest payments to corp increase. Should be > right out of the CFA texts on this one… My exam had interest expense…so i said: decrease. debt payments are locked in at a fixed rate…inflation goes up benefits the person who has debt…and hurts the person who issued the debt. IF variable rate w/ inflation real interest expense would not change. only logical answer is decrease.

>inflation goes up benefits the person who has debt That is wrong…

over05 Wrote: ------------------------------------------------------- > >inflation goes up benefits the person who has > debt > > That is wrong… how so? If i have liabilities and inflation increases i benefit because i’m locked in a lower rate…

you are saying the person who has the debt, how come he benefit when he locked in a lower rate??

i think you are confused. The person who has the debt is the person who makes the interest payments on the debt. That’s what i mean. I don’t understand your side, please explain, maybe i’m wrong. He benefits because his real cost of debt falls from an increase in inflation. If you were to take out a loan under a higher inflation environment you’d pay a higher rate.

I am confused by this: inflation goes up benefits the person who has debt…and hurts the person who issued the debt…you said ‘has debt’ is who makes int payments? so why then the ‘who issued the debt’?

over05 Wrote: ------------------------------------------------------- > I am confused by this: inflation goes up benefits > the person who has debt…and hurts the person who > issued the debt…you said ‘has debt’ is who makes > int payments? so why then the ‘who issued the > debt’? Ignore that part but just think of it this way. I issue you debt. All of a sudden inflation goes up 20000000000%. You can make your debt payments with your HUGE increase in nominal earnings because inventory prices will increase too. So your real cost of debt falls thus real interest expense of debt falls. For me, well it just hurst me because i would rather issue my debt at a higher nominal rate. You can keep paying my debt at 5% instead of 5% + 20000% which i can currently get in the market.

its an easy concept really… think of it this way If nominal interest is 10%—>expected inflation is 6% then real interest is 4% So if inflation is higher than expected, so higher than 6%, then real interest is less then 4% (since nominal stays the same) Same anaology here…the HIGHER the inflation the LOWER the REAL effects

thanks for explaining…guess the easier way to look at this is just that with any assets that are negatively correlated with inflation (except for commodities such as oil and gas) inflation increase will decrease the value of the assets. I thought too much on that question. It’s an easy one.

Inflation benefits the corporation that issues the debt. Obviously, the rate at issuance will include the risk free and the nominal interest rate. once the debt is issued, it’s coupon payments stay the same as does its principal. if later inflation jumps, the corporation doesn’t have to up its coupon or its principal repayment. Thus it benefits. Of course, the investor on the other hand is hurt because the coupon pmts are worth less. In the end, the real interest expense for the issuer has declined.

That is correct Lum…that is why all bond fund managers are super careful about inflation…

Lumiere_1979 Wrote: ------------------------------------------------------- > Inflation benefits the corporation that issues the > debt. Obviously, the rate at issuance will > include the risk free and the nominal interest > rate. once the debt is issued, it’s coupon > payments stay the same as does its principal. if > later inflation jumps, the corporation doesn’t > have to up its coupon or its principal repayment. > Thus it benefits. Of course, the investor on the > other hand is hurt because the coupon pmts are > worth less. > > In the end, the real interest expense for the > issuer has declined. Yah that’s basically what im saying but he is assuming the CO. issues debt and i was just assuming the company takes out debt from a bank…which makes the wording confusing =P

yes- I thought the question was from the issuing corp point of view- that is why I went with decrease / increase. maybe i read the question wrong i cant even remember