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Expected Inflation and the Constant-Growth Valuation Model

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  • 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. Copyright (c) 2008 Morgan Stanley.

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.
  • Handle: RePEc:bla:jacrfn:v:20:y:2008:i:2:p:66-78
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    File URL: http://www.blackwell-synergy.com/doi/abs/10.1111/j.1745-6622.2008.00181.x
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    References listed on IDEAS

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    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(03), 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.
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    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. 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.

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