Consider Two Companies Based in a Country with an Inflation

question 5

Essay

Consider two companies based in a country with an inflation rate of 2%. There is no real growth in earnings. The real rate of return required by global investors for this type of stock investment is 5%.
a. Assume that the Company A can only pass 60% of inflation through its earnings. What should be its P/E using prospective earnings?
b. Assume that the Company B can pass the full inflation through its earnings. What should be its P/E using prospective earnings?

---

Definitions:

Profit-Seeking Enterprise

A business or organization that operates with the intention of making a profit, as opposed to a non-profit organization.

Deferral Method

An accounting method where revenue or expenses are recognized after cash is exchanged, delaying the recognition of income or expenses until a future accounting period.

Government Grants

Funds provided by the government to organizations, businesses, or individuals for specific purposes, without any repayment obligation, often to support projects or innovations.

Private Donations

Contributions made by individuals or private entities to nonprofit organizations without expecting anything in return.