Inflation, Taxes and Corporate Value – The Dark Side of Real Growth

Abstract

This paper analyzes the combined effect of inflation and taxes on firm value, taking real growth of the firm's investment opportunities into account. Based on a simple model of the firm, our results highlight a hitherto neglected effect of real growth upon firm value. We find real growth, besides the well known positive effect of growing real cash flows, to carry a negative tax effect upon firm value. For the case of inflation, our model derives conditions under which increasing real growth rates may even reduce the value of the firm due to the negative tax implications. Moreover real growth also affects the sign and magnitude of the impact from changes in the corporate tax rate upon firm value. Our model suggests that increasing inflation rates generally destroy corporate value via negative tax effects. We also derive depreciation schemes establishing tax neutrality in corporate valuation.

Keywords: Inflation, Growth, Taxes, Valuation

JEL Classification: G32, M41