IDEAS home Printed from https://ideas.repec.org/a/bla/jacrfn/v20y2008i2p66-78.html

Expected Inflation and the Constant‐Growth Valuation Model

Author

Listed:
  • Michael Bradley
  • Gregg A. Jarrell

Abstract

In the presence of inflation, the standard Constant‐Growth valuation model found throughout the finance literature is not valid in cases where a company either (1) makes no net new investments or (2) invests only in zero Net Present Value projects. If expected inflation is positive, the generally accepted and widely used expression for the value of the firm under either of these two conditions seriously understates the true value of the firm, even with modest levels of inflation. The authors also show that the Weighted Average Cost of Capital (WACC), as developed by Modigliani and Miller (M&M), will be misleading if inflation is positive. They provide an adjustment factor that corrects this deficiency of the M&M model. Finally, the authors show that the WACC formula developed by Miles and Ezzell is correct when the parameters are stated in nominal terms, and therefore no adjustment is necessary.

Suggested Citation

  • Michael Bradley & Gregg A. Jarrell, 2008. "Expected Inflation and the Constant‐Growth Valuation Model," Journal of Applied Corporate Finance, Morgan Stanley, vol. 20(2), pages 66-78, March.
    • Handle: RePEc:bla:jacrfn:v:20:y:2008:i:2:p:66-78
    DOI: 10.1111/j.1745-6622.2008.00181.x
    as

    Download full text from publisher

    File URL: https://doi.org/10.1111/j.1745-6622.2008.00181.x
    Download Restriction: no
    File URL: https://libkey.io/10.1111/j.1745-6622.2008.00181.x?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    References listed on IDEAS

    as
    1. Miles, James A. & Ezzell, John R., 1980. "The Weighted Average Cost of Capital, Perfect Capital Markets, and Project Life: A Clarification," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 15(3), pages 719-730, September.
    2. Myers, Stewart C., 1977. "Determinants of corporate borrowing," Journal of Financial Economics, Elsevier, vol. 5(2), pages 147-175, November.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Jennergren, L. Peter, 2011. "The Conventional Formula for the Nominal Growth Rate of Free Cash Flows is OK -- A Comment on Three Recent Papers in the Journal of Applied Corporate Finance," SSE/EFI Working Paper Series in Business Administration 2011:6, Stockholm School of Economics.
    2. Stefan Dierkes & Ulrich Schäfer, 2021. "Valuation of firms with multiple business units," Journal of Business Economics, Springer, vol. 91(4), pages 401-432, May.
    3. Matthias Meitner, 2013. "Multi-period Asset Lifetimes and Accounting-based Equity Valuation: Take Care with Constant-growth Terminal Value Models!," Abacus, Accounting Foundation, University of Sydney, vol. 49(3), pages 340-366, September.
    4. Bernhard Schwetzler & Felix Bogateck, 2025. "The “Mission Impossible” of a Steady State, Value-Neutral Investments, and Value Maximization in Terminal Value Calculations," Schmalenbach Journal of Business Research, Springer, vol. 77(4), pages 1067-1099, December.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Kudret Topyan, 2021. "Levered-Beta and Cost of Capital Sensitivities: An Experimental Investigation in Capital Structure," JRFM, MDPI, vol. 14(4), pages 1-14, April.
    2. Parrino, Robert & Weisbach, Michael S., 1999. "Measuring investment distortions arising from stockholder-bondholder conflicts," Journal of Financial Economics, Elsevier, vol. 53(1), pages 3-42, July.
    3. Xiao, Chang & Florescu, Ionut & Zhou, Jinsheng, 2020. "A comparison of pricing models for mineral rights: Copper mine in China," Resources Policy, Elsevier, vol. 65(C).
    4. Laurence Booth, 2007. "Capital Cash Flows, APV and Valuation," European Financial Management, European Financial Management Association, vol. 13(1), pages 29-48, January.
    5. Nguyen Kim-Duc & Pham Khanh Nam, 2024. "Consistent valuation: extensions from bankruptcy costs and tax integration with time-varying debt," Review of Quantitative Finance and Accounting, Springer, vol. 62(2), pages 719-754, February.
    6. Barbara Su, 2023. "Banking practices and borrowing firms’ financial reporting quality: evidence from bank cross-selling," Review of Accounting Studies, Springer, vol. 28(1), pages 201-236, March.
    7. Pablo De Andrés‐Alonso & Valentín Azofra‐Palenzuela & Gabriel De La Fuente‐Herrero, 2006. "The Real Options Component of Firm Market Value: The Case of the Technological Corporation," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 33(1‐2), pages 203-219, January.
    8. Finaldi Russo, Paolo & Nigro, Valentina & Pastorelli, Sabrina, 2024. "Bank lending to small firms: Metamorphosis of a financing model," International Review of Economics & Finance, Elsevier, vol. 90(C), pages 13-31.
    9. Valérie Oheix & Dorothée Rivaud-Danset, 2009. "Why do firms borrow on a short-term basis ? Evidence from European countries," Working Papers hal-04140880, HAL.
    10. Yoshiaki Ogura & Ryo Okui & Yukiko Umeno Saito, 2025. "Network-Motivated Forbearance Lending," Management Science, INFORMS, vol. 71(11), pages 9766-9783, November.
    11. Schauten Marc B. J., 2013. "Three discount methods for valuing projects and the required return on equity," Contaduría y Administración, Accounting and Management, vol. 58(1), pages 63-85, enero-mar.
    12. Loncarski, I. & Ter Horst, J.R. & Veld, C.H., 2006. "Why do Companies issue Convertible Bond Loans? An Empirical Analysis for the Canadian Market," Discussion Paper 2006-65, Tilburg University, Center for Economic Research.
    13. Khémiri, Wafa & Noubbigh, Hédi, 2020. "Size-threshold effect in debt-firm performance nexus in the sub-Saharan region: A Panel Smooth Transition Regression approach," The Quarterly Review of Economics and Finance, Elsevier, vol. 76(C), pages 335-344.
    14. Shaikh, Ibrahim A. & O'Brien, Jonathan Paul & Peters, Lois, 2018. "Inside directors and the underinvestment of financial slack towards R&D-intensity in high-technology firms," Journal of Business Research, Elsevier, vol. 82(C), pages 192-201.
    15. Chava, Sudheer & Purnanandam, Amiyatosh, 2010. "CEOs versus CFOs: Incentives and corporate policies," Journal of Financial Economics, Elsevier, vol. 97(2), pages 263-278, August.
    16. Norvald Instefjord & Turalay Kenc, 2024. "Implementing Real Options Valuation under Macroeconomic Risk and Normally Distributed Cash Flows," International Econometric Review (IER), Economic Research Association, vol. 16(1), pages 50-67, June.
    17. Peter Brusov & Tatiana Filatova & Natali Orekhova, 2023. "Capital Structure Theory: Past, Present, Future," Springer Books, in: The Brusov–Filatova–Orekhova Theory of Capital Structure, chapter 0, pages 9-50, Springer.
    18. Ewald, Christian Oliver & Taub, Bart, 2022. "Real options, risk aversion and markets: A corporate finance perspective," Journal of Corporate Finance, Elsevier, vol. 72(C).
    19. Lucey, Brian M. & Zhang, QiYu, 2011. "Financial integration and emerging markets capital structure," Journal of Banking & Finance, Elsevier, vol. 35(5), pages 1228-1238, May.
    20. Nguyen, Thao & Bai, Min & Hou, Greg & Vu, Manh-Chien, 2020. "State ownership and adjustment speed toward target leverage: Evidence from a transitional economy," Research in International Business and Finance, Elsevier, vol. 53(C).

    More about this item

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:bla:jacrfn:v:20:y:2008:i:2:p:66-78. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Wiley Content Delivery (email available below). General contact details of provider: http://www.blackwellpublishing.com/journal.asp?ref=1078-1196 .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.