Financial Projections in Real and Nominal Terms  505
Step 5: Estimate DCF Value in Real and Nominal Terms
When discounting real and nominal cash flows under high inflation, you must 
address three key issues:
1. Ensure that the weighted average cost of capital estimates in real terms 
(WACCR) and nominal terms (WACCN) are defined consistently with 
the assumptions for inflation (i) in each year:
1+WACC = 1+WACC
1+
N
R
t
t
ti
(
)(
)
2. Make sure the explicit forecast period is long enough for the model to 
reach a steady state with constant growth rates of free cash flow in the 
year when you apply the continuing-value formula. Because of the way 
inflation affects capital expenditures and depreciation, you need a much 
longer horizon than for valuations with no or low inflation.
3. The value driver formula as presented in Chapter 14 can be readily ap-
plied when estimating continuing value in nominal terms, but it should 
be adjusted when estimating in real terms in high-inflation environ-
ments. The return on capital in real-terms projections (ROICR) overes-
timates the economic returns in the case of positive net working capital. 
The free cash flow in real terms differs from the cash flow implied by 
the value driver formula by an amount equal to the annual monetary 
loss on net working capital:
FCF = 1
ROIC
NOPAT
NWC
1+
R
R
R
R
1
R
t
t
t
t
t
t
t
g
i
i
−






−






−
where gR is growth rate in real terms, and NOPATR is net operating 
profit after taxes in real terms. The real-terms value driver formula is 
adjusted for this monetary loss, reflecting the perpetuity assumptions 
for inflation (i) and the ratio of net working capital to invested capital 
(NWCR/ICR):
CV =
1
G
ROIC
NOPAT
WACC
R
R
R
R
R
R
−




−g
where
G =
+ N
C
IC
1+
R
R
R
R
g
i
i
W









506  Inflation
The resulting continuing-value estimate is the same as that obtained from 
an FCF perpetuity growth formula. After indexing for inflation, it also equals 
the continuing-value estimates derived from nominal projections.
Of course, the DCF valuations in nominal and real terms should lead to 
exactly the same result. Combining both approaches not only provides addi-
tional insights into a company’s economics under inflation but also is a useful 
cross-check on the validity of the valuation outcomes.
Summary
High and persistent inflation destroys value because companies typically can-
not increase prices enough to offset higher capital outlays. To analyze and 
value companies in the presence of such inflation, we use the same tools and 
approaches as introduced in Part Two. However, applying them can be some-
what different.
When analyzing a company’s historical performance, you should be aware 
that persistent inflation can distort many familiar financial indicators, such as 
growth, capital turnover, operating margins, and solvency ratios. Ensure that 
you make appropriate adjustments to these ratios. When making financial 
projections, use a combined nominal- and real-terms approach, because real-
terms and nominal-terms projections offer relevant insights and can be used 
for cross-checking your results. When discounting cash flows, use inflation 
assumptions in the weighted average cost of capital that are fully consistent 
with those underlying your cash flow projections.

507
27
Cross-Border Valuation
To value businesses, subsidiaries, or companies in foreign countries, follow 
the same principles and methods that we presented in Part Two. Fortunately, 
accounting issues in cross-border valuations have diminished. Most of the 
world’s major economies have adopted either International Financial Re-
porting Standards (IFRS) or U.S. Generally Accepted Accounting Principles 
(GAAP), and these two standards are rapidly converging. Moreover, remem-
ber that if you follow Chapter 11’s recommendations for rearranging financial 
statements, you will obtain identical results regardless of which accounting 
principles you follow in preparing the financial statements.
Nevertheless, the following issues arise in cross-border valuations and still 
require special attention:
• Forecasting cash flows, whether in foreign currency (the currency of the 
foreign entity to be valued) or domestic currency (the home currency of 
the person performing the valuation)
• Estimating the cost of capital
• Applying a domestic- or foreign-capital WACC
• Incorporating foreign-currency risk in valuations
• Using translated foreign-currency financial statements
This chapter highlights the steps involved in the special analyses required 
for each of these issues.
Forecasting Cash Flows
A company or business unit valuation should always result in the same value 
regardless of the currency or mix of currencies in which cash flows are pro-
jected. To achieve this, you should use consistent monetary assumptions and