Inflation, Investment and Valuation
20 Pages Posted: 20 Nov 2020 Last revised: 22 Feb 2021
Date Written: February 15, 2021
In any context where a discounted cash flow valuation is required, there is the issue of estimating the continuing value. The most common way to do that is to assume that by the terminal horizon the company is in a steady state and is growing at a constant rate. The issue is how to handle inflation. The problem is that it is often done wrong and the impact is typically material. Because there remains significant confusion, in this paper we simplify the analysis by isolating the two key issues and providing example calculations. We show that even at the current 2% level proper treatment of inflation has a size-able impact on valuation. If inflation were to accelerate as a result of current monetary and fiscal policies, the significance of this issue will increase.
Keywords: inflation, investment, valuation
JEL Classification: G00, G10
Suggested Citation: Suggested Citation