University of Nigeria               Research Publications 

OKAFOR, Chris Obi

Aut

hor

PG/MBA/88/7175

Title

Effects of Inflation on Project Evaluation and Capital Budgeting in Nigeria (1980-1990)

Facu

lty

Business Administration

Dep

artm

ent

Banking and Finance

Dat

e

June, 1993

Sign

atur

e

EFFECTS OF INFLATION ON

PROJECT EVALUATION AND CAPITAL

BUDGETING I N NIGERIA (1980 'to 1990).

OKAFOR CHRIS OBI

PG/MBA/88/7175

DEPARTMENT O F BANKING AND FINANCE,

UNIVERSITY OF NIGERIA , ENUGU CAMPUS

JUNE, 1993.

EFFECTS OF fNFLATION ON

PROJECT EVALUATION AND CAPITAL

BUDGETING tN NIGERIA

(1980 to 1990)

OKAFOR CHRIS OBI

PGIMBAI8817175

A PROJECT REPORT submitted In Partial Fulfilment of the Requirements

for the award o f the Degree of Masters of Buslness Admlnkttration IMt3kl

i n Banking and Finance o f the University o f Nigeria.

Faculty of Business A d m i n i s i r d ~ ~ o r ~ , u e ~ d r L I W I ~ L of Banking and Finance

University of Nigeria

Enugu Campus

June, 1 9 9 3 .

C E R T I F I C A T I O N

OKAFOR CHRIS OBI, a post-graduate student in the Department of Banking

anf Finance, and wlth Registration Number PGIMBA/88/7175, has satisfactorily

completed t h e requirements for course and research work for the degree of

Master of Business Administration in Banking and Finance.

This dissertation i s an embodiment of original work and has not been submltted

in pa r t o r in full for any other diploma o r degree.of this o r any o ther University

Head of ~ e p a r t m e n t Dr. J. N. Ezikpe (Supervisor)

D E D I C A T T O N

This work is dedicated to my 'Squad'

Jayne - My darling wife

Ozioma - Tie. Commanding Officer

~ d e obi - Brain teaset

Lota - 1 ndefatigable

Kosa l u - M y twin intellect

Ka'etoo - Resilient power-pack

They made it a team a f f a i r .

A B S T R A C T

Capital Budge t ing and Proiect Evaluation both refate to.p1'anning investment

, expendi tures whose re tu rns are expected to extend beyond one year, and

assessing, a t the end o f

to i t s set objectives.

the period, the performance of the project, re la t ive

In this work, t he impacts o f Inf lat ion (a general r ise in prices) on b o t h key

aspects o f investment were studied, over an eleven year per iod (1980 - 1990).

To do this, in f la t ion data cbmputed from the Annual Consumer Pvfce indexes

were used t o analyze financial Items inseparate authenticated Balance Sheets

and Pro f i t and Loss Accounts of four Companies. Return on Investment, a

measure o f prof i tab i l i ty , was doubly ascertained f o r each company; (i) without

inf lat ion a n d (ii) w i t h inflation. The analyses o f data showed a pers is tent

percentage d r o p in Retrun on Investments that ranged from 0.99 in a low

inf lat ion year to 33.23 In a year o f relatively high inf lat ion. Results o f these

analyses and subsequent tests of: hypotheses revealed that:

1. In f la t ion reduced t he real value o f f ixed and total assets o f each of t h e

Companies investigated,

2 . In f la t ion h a d a negative influence on the p r o f i t performance o f each

company as it depressed the ra te o f turn-over o f assets,

Th i s revelat ion has re-lnforced the need t o include in f la t ion conslderatlons

white p rov i d i ng pro~ec2/investment capltal, and in evaluation o f project

pro f i tab i l i ty , especfally fo r projects whos gestation per iod would l ikely

exceed one year.

iii

He d ic ta ted it altogether, God the Almighty; I adore him inf in i te ly.

My supervisor, Dr. S.N. Ezike - Managing Director NAL Merchant Bank PIC.

He accommodated my lapses, rest ructured my inputs, t o produce th is i l luminat ing

piece o f work; I thank him immensely.

Mr. L.E. Okafor, erud i te banker, Managing Director and Chief Executive ,United

Bank fo r Afr ica Pic. He inst igated this study, motivated it and refused to take

'No' f o r a n answer. He remains an Pndlspensable inspiration. Brother, I d o f f my

hat. His wife (my wife), Mrs Vee Cee Okafor IAkanwezeJ, She too was desperate

f o r my success; Cod bless her.

S i r . (-Engr) A. I. Okafor (Okaaomee) ; ve ry benevolent elder brother, spent sleepless

n igh ts wo r r y i ng to see the end o f this study. I p r a y God to protect and gu ide

him.

Mr. ~ d n a Onwugharu, Dlrector (Computer] , National ~ o b u ~ a t i o n Commission,

Enugu Zone, my good fr lend. He v i r tua l ly served me w i t h many'queriest l o show

cause why th i s work should l inger on. 1 thank him ernest ly.

Bar r i s te r Emma Uyanwa, Secretary/Legal Adviser o f former Diamond Breweries Ltd,

Enugu. He prov ided the bulk of data from h is company a t a time when dear th

o f consistent data proved a n obstacle to th i s work, I owe him a lot.

My parents Chief and V r s J.A. E V.M. Okafor; My parents in-law, Ide D.C.

Odenigbo and lyom V. Odenlgbo; they formed a team o f Solicitors, request ing God

to successful ly complete th is work. May Cod soothe the i r aching knees and

reward t he i r many other supplications.

My good f r i end and bestman, Dr. J.U.J. Onwmere, Economist and Econonretrist;

he demonstrated the rarest quall t les o f g w d f r iendship by ca r r y i ng th is cross

wi th me, read and re-read my or ig inal draf ts. I cannat thank hfm enough.

My recurring decimal, my beloved wife Jayne; she proved more than a better-

half, encouraged thls study and worked tirelessly for thls. end. "Mmanrvanyi

bu diyal', I love you dearly.

Enugu, Nigeria

June, 1993.

Chris Obi Okafor

TABLE OF CONTENTS

CERTIFICATION

DEDICATION

ABSTRACT

ACKNOWLEDGEMENT

TABLE OF CONTENTS

LIST OF FIGURES

LIST OF TABLES

CHAPTER ONE: INTRODUCTION

1.1 Background t o the Study

1.2 Problem Identif icatfon

1.3 Objectives o f the Study

1.4 Hypotheses o f the Study

1.5 Significance of the Study

1.6 Limitations o f the Study.

CHAPTER TWO: REVIEW OF RELATED LITERATURE

Nature and Dimensions o f lnfal t ion

His tory o f lnf lat ion

lnf lat ion and War - A 'Since quanon'?

Def in i t ion o f lnf lat ion

Types o f lnf lat ion

Causes o f tnf lat lan

l nf lat ion or Unemployment?

Estimating lnf lat ion

Inf lat ion: The Nigerian Experience

in f la t ion and Project Evaluation

Inf lat ion and Capital Budget ing

Why Worry about Inf lat ion ?

CHAPTER THREE: RESEARCH METHODOLOGY

3.1 Preamble

3.1.1 Prof i tab i l i ty Measures

3.1.2 Earn ing Power

3.2 Sources of Data

3.2.1 l nf lat ion Rate

3.2.2 Prof i tab i l i ty

3.3 Sampling Procedure and Sample Size

Page

Page

3.4 Instruments for Data Collection

3.5 Techniques of Data Analysis

CHAPTER FOUR: PRESENTATION AND ANALYSIS' OF DATA

4.1 Data Presentation, Analysis and Results

4 .2 Test of Hypotheses

CHAPTER FIVE: SUMMARY OF FINDINGS, CONCLUSIONS AND RECOMMENDATIONS.

5.1 Summary of Findings

5.2 Conclusions

5.3 Recommendations

5.4 Area of Further Investigation

LIST OF TABLES Page

Consumer Price Index Levels 1979

The Phill ips Curve

R Coy L t d Balance Sheet as a t 31 ~ e c . 1980 11 I1 II 11 I1 I1 I! I1 11 1 98 1

X Coy L t d Balance Sheet as a t 31 Dec. 1982 II II II I1 11 I1 11 I1 11 1983

Y Coy L t d Balance Sheet as a t 31 Dec. 1984 If II 11 I1 I 1 I1 11 11 I1 1985

II I1 11 II 11. 11 I1 11 , 1 9 8 6

I 1 I1 I 1 I 1 I1 II I1 I 1 S 1987 11 I1 I1 11 11 11 11 I1 R 1988

II n PI M 11 II 18 II a 1989

Z Coy Ltd Balance Sheet as a t 31 Dec. 1990

APP.1 R Coy Ltd Prof l t and Loss Account 1980 - '8'1

APP.2 X Coy ttd Prof i t and Loss Account 1982 - '83

APP.3 Y Coy Ltd Prof i t and Loss Account 1984 - '85

APP.4 " II II II II 1986 - '87

APP.5 " I1 11 I f II II 11 1988 - '89

APP.6 ' Z Coy Ltd Prof i t and Loss Account 1990 '

LIST O F FIGURES

Fig. 2.1 - Differentiat ing Between Inflat ion Types

Fig. 2.9.1 - The Phlll ips Curve

v i i i

CHAPTER ONE

I N T R O D U C T I O N

1.1 . Backg round To The S t u d y

In f l a t i on has been def ined as a r ise in the average p r i c e level. In a

dynamlc economy, p r i c e changes take place constant ly . Sometimes, t h e pric

o f a pa r t i cu la r good o r service may exh ib i t a n u p w a r d o r downward t r e n d

t h a t can last f o r months, years or even decades.

I n i t i a l p r i c e changes as a resu l t o f sh l f t s in t h e supp ly a n d demand f o r

p a r t i c u l a r goods and services do n o t imply a n y change in t h e general p r i c e

level. A change in t h e average p r i ce level takes place i f the re i s a s t r o n g

tendency f o r a l l p r ices to move up or down in p ropor t i on to ane another.

Such r i s e in t h e average pr ice level is Inf lat ion.

Modern count r ies have all, almost wi thout exception, su f fe red p e r i ~ d s o f

inf lat ion. Generally, attempts have been made t o cont ro l these inflation,

both In s e v e r l t y and !in the l r d u h t i o n . In some o the r instances. t he

accelerat ion in t h e ra te of increase in pr ices had been seeming mrnanag-

eable. The German inf lat ion o f 1923 (Chu and Feltenstein, 1979) saw

p r i c e increases r i se t o a peak o f more than 30,000 percent a month, a n d

the economy was reduced t o funct ion on t he basis o f ba r te r .

A l though n o cases o f such violent in f la t ion has been recorded in the most

recent t h e , few cases have been where f o r a considerable l eng th o f time,

the ra te of p r l c e increases tended t o b e o u t o f contro l .

In Nigeria, t h e index o f pr ices has been cont inuously o n t h e increase since

1960 (A jay i a n d Ojo, 19811,although the p r i c e increases since 1976 have

however been o f more slgniflcance. The rate o f in f la t ion between 1969 and

1970 was about 10% which rose immediately a f t e r t he C iv i l War in 1970 to

about 74 p e r cent, and to 16.1 percent in 1971. A f t e r a itill' between 1972

and 1973, the consumer pr ices index rose again f r om 213.6 in 1974 to 286.4

in 1975 (Base 1 9 6 0 ~ 1 0 0 ) ;an increase in inf lat ion ra te o f about 34 p e r cent.

tn f ta t lon can emanate f rom a va r ie t y of sources. C h u a n d Feltenstein (1979)

repo r ted t h a t two studies on inf lat ion made t o cover betw.een 1963 a n d 1976 in

Argen t ina showed tha t t he re were essentially two main causes o f t h e in f la t ion in

t h a t c o u n t r y a t t h e time. T h e f i r s t cause was t he b u d g e t def ic i t o f t h e Centra l

Government, whi le the second was government p r i ce controls, which paradoxlcal ly

i s a n instrument used by government t o attempt t o check the r ise in prices.

In t h e opinion o f Ajayl and Ojo (1981) t he two major factors wh ich combined t o h(

inf luences on in f la t ionary t rends in Nigeria were 1. shlktage o f suppl ies ( t h e

coro l la ry o f excess demand], and 2. monetary factors, such as t h e r i s e in

government expendi ture; increases in money incomes a n d increases in money supp

These vfews seem to have been shared by(Ciroma (1976) when as Governor o f t h e

Cent ra l Bank o f Nigeria, he voluntered hfs opinion on t h e predisposing factors o f

t he Niger ian in f la t ion and stated; i n t e r slia:

I' t he banks have substantlel funds - f o r wh ich they a re

apparent ly not f i nd ing as much investment out let as t h e y

would wish, and t h i s v e r y h i g h liquidity o f t h e commercial

bank ing system could be a source o f f u r t h e r monetary instabl l l ty l l

[ Ciroma, 19761 ,

One major resu l t o f t he r a p i d bui ld-up o f purchas ing power in the Niger ian econol

a t t h e tlme, was the acute in f la t lonary pressures which had been the experience

of several years. Again, in the vlews o f Ciroma ( i b id ) among the fac tors under -

lining t h e in f la t ion inc luded insuf f ic ient p roduct ion o f t h e domestic market, added

t o inadequate capacity t o augment th rough iinpwtdtion and compounded by p o r t

congestion which had done severe damage to the economy.

One disadvantage o f an unstable p r i ce level i s t ha t it makes t h e task of appropr ia

te l y analyz ing the economic advantages and disadvantages o f d i f f e ren t investment

a l ternat ives more d i f f i c u l t and complex. Capital budget ing, a n inherent aspect o f

investment decisions i s a many-sided ac t lv l ty t h a t includes searching f o r new

a n d more pro f i t ab le investment proposals. Of ten times, i t involves i nves t i ga t i ng

engineer ing a n d inarketirrg consldesatlon to p r e d i c t t he consequences o f accept ing

t h e fnvesitment a n d making economic analyses t o determine the p r o f i t potent ia l of

each investment proposal. By assuming tha t t he consequences of a n investment

can be descr ibed In terms o f cer ta in o r unce r ta in cash flows it w i l l genera te in

each tlme interval , one c a n thence exclude many investments. A l t h o u g h not all

investlrnent decisions in a n organization can be descr ibed l n Naira terms, importal

decisions descr ibable in these terms, nonetheless, w c u r In most modern organiza-

t ions.

The cent ra l focus o f a n investment analysis there fore i s the comparison between z

si tuat ion w i t h the Investment and that wi thout it. T h e net e f fec t o f the invest-

ment Is found by deduct ing the flow o f costs a n d benef i ts w i thout t h e investment

f rom the same f low represent ing the s i tuat ion wlth the investment. A l though

t h e pr inc ip les of capl ta l budgeting a r e applicable when there i s a r i s k o f in f la t ion

as well a s when t h e r i s k Is.neglible, these pr lnc lp les however, become d i f f i c u l t

to apply when t h e r i s k o f in f la t ion essurnes a pr l rnary importance a n d the i n f l a t i o ~

I s significant. In that case, f u t u r e cash flows may d i f f e r , no t on l y in the i r t imir

b u t also In t h e l r purchas ing power.

1 . 2 Problem identification

Most comparisons o f project ( investment] p ro f l tab l l l t y , l i qu id i t y a n d n e t w o r t h are

o f t e n done on the assumption tha t the value o f t h e monetary u n i t remalned stable

during the yea rs u n d e r consideration. Experience has shown, however, t ha t a

cont i r iu ing high level o f inf lat ion has so reduced the purchas ing power o f t he

Naira from year to year, thet the monetary values tn successive f l na l accounts

a n d capital budge ts do n o t g i ve real ist ic up-to-date values f o r p r o p e r assessment

o f ne t ~ 4 t h and pro f i tab i l i t y . The implication is t ha t , in per iods of inf lat ion,

holders o f monetary sssets could lase purct7ase pwr w h i l e owners o f physical

assets improve t h e i r wealth base.

In evaluat ing capi ta l budget decisions therefore, a businessman o r business

analyst Must consrder n o t on l y the possible ef fects o f inf lat ion, but also the

e f fec t of long term t rends In the re lat ive pr ices o f h i s a n d o the r products .

Repor t ing I r v i n g Fisher, Farna a n d Schwert (1977) had noted t h a t t h e nominal

y ie ld o n a n asset can b e expressed as t h e sum o f a n expected rea l r e t u r n and

an expected i n f l a t i on rate. In the i r views, i f t h e market was a n e f f i c i en t processc

o f informat ion available a t time t-1 , it wi l l se t the p r i ce o f any asset, j, such tha i

t he expected nominal r e t u r n o f t he asset f rom t-1 t o t . w o u l d be t h e sum o f t h e

appropr ia te equ i l ib rum expected real r e t u r n a n d the best possible assessment o f

t h e expected in f la t ion rate, f rom t-1 t o t. Represented in the fo rm o f a n equatior

E(Rjt/Ot-1) = E(Tjt/t-1) .t E(Dt/O-t-l 1 . . . . . l e i

Where R j t = Nominal r e t u r n o n asset j f rom

t - 1 t o t

E ( T j t / B j t ) = appropr ia te equi l ibrum expected real r e t u r n

on t he asset implied by t h e set o f in format ion €bt -1

avai lable at t-1

E(&/Qt-1) = T h e best possible assessment o f the expected value o f in f la t ion

rate , Dt, tha t can be made on the basis o f Ot -, The message belng conveyed b y Equation 1 . 1 above i s tha t t he market uses

B t - 1 co r rec t l y assess t h e inf lat ion rate a n d t o determine the appropr ia te

equ i l ib r ium expected real r e t u r n on asset j, inc lud ing perhaps, a r i s k adjustment

which d i f fe rent ia te t h e expected r e t u r n on asset j, f rom tha t on o the r assets.

T h e market t hen sets the p r i ce of the asset so t h a t i t s expected nominal r e t u r n

becomes the sum o f t he equi l ibrum expected rea l r e t u r n a n d the c o r r e c t l y

assessed expected [nf la tion.

From t h e foregolng, It becomes apparent that t he issue at stake I s whether

In f la t ion Improves a r reduces the pro f i tab i l i t y and n e t wor th o f a p ro jec t o r

Investment.

1.3 Objectives of t h e Study

T h e fundaniental mechanism for economk evaluation o f investment opt ions

i s t h e Net Present Value [NPV) formular. T h i s states t h a t t h e present

value o f an investment option i s the sum of the discounted cash f lows

associated w i t h t h a t option. Present va lue is a stock concept. T h u s

t h e re levant cash f lows are equated w i t h a stock of new wealth by Caplta-

l izat ion a t t he cos t o f capital approprate to that investment. Bussey (1978

put it in a n equat ion form thus:-

Where

Po = t h e Net Present Value

Y t = t h e net cash flow at the end of per iod t.

N = t h e l i fe o f the project.

i = t h e discount ra te fo r t h e period.

t = t h e po in t i n tlme under considerat ian

,i.e. t = 0,1 ,2 , ; .....,.. N

Underthese conditions, the NPV is a po in t estlmafe, a s ingle value a t a

par t icu lar in teres t (discount] ra te i . In practise, for the f irm, once

t h e NPV is positive, t he pq'ect i s accepted, but rejected i f otherwise.

Inc idental ly t h e NPV method does no t p rov ide for t h e v ic iss i tudes o f

in f la t ionary pressures and seems to re late more to a n "a prlori" pro jec t

evaluation.

T o determine the pro f i tab i l i t y of an itwestment, one o f t h e most widely

used measures i s t h e r e t u r n on Investments (where investments i s to ta l

assets ( less in tang ib le f i xed assets) + V i cke ry [I9731 had maintained t h a t

W W W t he na tu re o f f ixed assests, t h e y a r e he ld solely f o r t h e pu rpose0

earn ing revenue a n d not pu re l y for sale. They a r e usua l ly valued a t cost

and: the amount o f f i xed assets whlch a r e shown in the Balance sheets

does not represent the i r realisable value, but usually historic record o f th ier

cost.

it wi l , b e the objectives o f this s tudy therefore:

1. Use In f la t ion data to analyze assets financial values i n successive

Balance Sheets and present them in uniform, inflaflon-adjusted

monetary values.

2 . Discover t he effect of lnf laiton on Capital Budgeting by comparison

o f the adjusted assets values with the unadjusted values and thence

3. State more reallstlcally the real prof i tabHlty and wealth o f an Investment.

1.4 Hypotheses of the Study

For the purpose o f th is study, we state two hypotheses, namely:

Hypotheses1 : l nf lat ion negatively affects the real r e r u r n on a project

investment.

Stated mathematically, we have that

Where

Ho = Null Hypotheses

HA = Al ternat ive hypotheses

~ r t incorporat ing inf lat ion on asset values a t time t.

f t = Return on Investment with inf lat ion-neutral

asset values a t time t.

Decision Rule

I f N - J j t ) , f t

accept null hypotheses

4 N T t < f f

accept t h e al ternat ive hypotheses

Hypotheses I I : Inf la t ion reduces the values o f investment assets

Stated mathematically

Ho: NWt - - W t

Ha: NWP # W t

Where

NWt = Adjusted value of assets under Inf lat ion a t time t.

W t = Hts tor ic value o f assets a t time t.

Decision Rule

If NWt 4 W t

accept u i l hypotheses

I f NWt > Wt

accept t h e s l terna t i ve hypotheses

1.5 Siqni f icance o f the S tudy

T h e s t u d y i s s ign i f i cant because i t would emphasize the need to acknowledge

in f l a t i on considerat ions in estimating o f investment p ro f i t ab i l i t y a n d v iab i l i t y .

F o r "a p r i o r i " pro ject evaluation, i t would encourage a more real is t ic assessment

of a project 's chances o f success. I n most cases recently, companies have had

t o r e p o r t huge levets o f p r o f i t only to d iscover t h a t such jumbo p r o f i t s f izzle

out in asset maintenance and replacement costs prec ip i ta ted by in f la t ion .

6.1 L imi tat ions o f the S tudy

T h i s s t u d y i s notal l embracing, fo r many reasons:

1. Risk adjustment, which di f ferent iates the expected r e t u r n s o n one asset

from tha t on another was not introduced, and as such, on l y t h e general

7

' effects.of inf lat ion are highlighted with respect to each asset or .pro ject

investigated.

2 . Inf lat ion data a re o f tern retrospective. The analysis i s essential ly l i ke

a post-mortem. It can therefore only prescr ibe fo r the f u t u r e by implication

Besides, since inf lat ion Is time variable, the respective effects determined in

th is s tudy relate on ly to the periods covered by the investigation. More

so, inf lat ion data used in th is work are the A l l i tem composite Consumer

Price index, not those of specific assets,.

3 . The work did no t compare the effects o f Inf lat ion on one company relative

t o the other. Al though this i s outside the scope o f the present study,

pauci ty o f consistent and regular data on any one company dld no t allow

f o r any such comparison,

CHAPTER TWO

REVIEW OF RELATED LITERATURE

Nath-e and Dimensions o f Inf lat ion

Inf lat ion, bo th now and in the past has cont inued t o confront policy-makers

throughout the wor ld as a dominant economic problem, Developing c0uh.t r ies

exper iencing g row th are often inundated w i th inf lat ion. Developed count r ies

usual ly have some form o f inf lat ion which i s inevi table for growth.

Inflation, which i s manifested by a general increase In the pr ices o f goods and

services var ies bo th in sever i ty and duration. I t can also resu l t f rom a var ie ty

o f causes and the main consequence is that i n f fa t i i causes a reductionin:& purchasing

power o f t he local cur rency.

2.1.1 H is to ry o f In f la t ion

Inf lat ion has now been proclaimed the cr i t ica l problem o f the indust r ia l ised society

and probably, I t s obsession(~evinson, 1971). Th is applies to a l l economiers

irrespective o f the i r levels o f Industriaiisatioh o r development. It i s ,not a new

phenomenon.

Throughout the ancient periods, the M.editerranean civ i l i ret lons f requen t l y experi-

enced h igher pr ices In terms of metallic currency, due to t he discoveries o f new

mines. The ear ly Mediterranean wars also caused lnf lat lon as a resu l t af the

release of hoards o f metallic money accummulated th rough pillage. Acquis i t ion

o f substant ia l quant i t ies o f gold and si lver by conquer ing Roman Emperors had

in f la t ionary fmpacts in the Kingdom, and f requent debasements [devaluation) o f

the coins in ancient China, Greece and Rome resul ted in inf lat ion.

in f la t ion i s n o t a ra re phenomenon In economic h'lstory. In the mlddle ages, it

was not unknown, despite the constra!nts of a general scarci ty o f t h e prec ious

metals. The discovery o f the New World produced a prot racted in f la t ionary

episode o f a t least West European extent, and each of the World Wars has been

known to b r i n g in f la t ion on an international scale. A fa i r number o f local

occurencies of inflation have also been known.

The inflation of u p till 1980 had been both extensive and sever, judging from the

consumer price index level as shown .on Table 2.1.

Table 2.1 Consumer Pr ice Index (CPI) Levels 1979

(Base 1950 =I)

COUNTRY

Argent ina

Uruguay

Bol iv ia

B raz i l

South Korea

l srael

Iceland

Paraguay

Ghana

PerO

T u r k e y

. Colombia

Yugoslavia

Spain

Mexico

Portugal

l re land

Fin land

Greece

I r a n

Un i ted Kl ngdom

New Zealand

I t a l y

Japan

France

Aust ra l ia

Denmark

CPI

100,000.0

12,000.0

719.0

275.0

183.0

80.5

60.4

54.0

50.0

45.3

40.3

29.2

15.0

10.6

9.7

7 .9

7.0

6.7

6.6

6.5

6.3

6.2

5.9

5.7

5.7

5.5

5.5

COUNTRY

Phillipin'es

Sweden

Norway

South A f r i c a

l ndia

Aust r ia

Morocco

Costa Rica

Netherlands

E l Salvador

Burma

Canada

Tunis ia

Belgium

Uni ted States

Dominican Refxlbli

Egyp t

Malta

Guatemala

S r i Lanka

Switzerland

West Germany

Malaysia

CPI

5.5

5.0

4.9

4.9

4.3

4.1

4.1

3.6

3.4

3.4

3.4

3.2

3.2

3.1

3.0

3 .O

2.9

2.7

2.7

2.6

2.5

2.4

2.1

Source: B r o w n a n d Darby 119851 p.2.

In their opinion (Brown and Darby 1985) no market economy avoided the inf lat ion

o f the per iod and none.seemed. t o have escaped w i t h less than a doubl ing o f i t s

consumer p r i ce index. Cnly the off icial price.s o f some central ly - planned economies

[ the USSR, (&echoslbvak'ii :as a t that time- and Bulgar ia) show2d v i r t ua l l y no

increase; and those o f some others (Poland Hunga ry ] showkidonly a small one.

The ilnternational Monetary Fund (IMF) gave a wor ld (weighted] average increase o f

5.3 fold, and the median count ry increase (see Table 2.1.) i s about the same figure

The United Nations indices for United States doll,ar pr ices o f internat ional ly t raded

goods showed a 3.6 fo ld increase in the case o f manufactures and a 4.8 fold in tha t

of pr imary products. A greater number o f market economies showed increases

between two and seven fold; Not many (mexico, 9.7; Spain, 10.6; Yugosslavia 15.0)

showed higher increases than that un t i l one go t to the v e r y much h igher ones o f

between 30 and 80 fo ld (Col.ombia,Chana, Israel, Peru and ~ u r k e ~ ) , t o 12,000 fo ld

(Uruguay) and 100,000 fold (Argentina).

Compared wi th World War periods however, Brown and Darby (1985) maintained

tha t recent lnf lat idns have produced larger p r i ce Increases f o r e t h e general i ty

of countries, but no truly hyper-inf lat ionary f i reworks, 'Cagan ( 1 956) def ined

hyper- inf lat ion a rb f t r a i i l y as a sett ing in whlch pr ices rose 50 percent in a month).

G r i f f i t h C1976) repor ted that one o f the earl iest records o f a rap id r i se in the

pr ice level was in ancient Greece around 330 BC, fol lowing Alexander the Great's

conquest o f Persia and h is t ransfer o f newly acquired go ld to Greece. Gold thus

replaced si lver as money and prices and wages rose throughout the whole Hellenic

Empire. lnsp i te o f this, the Greek States, even on t he verge o f b a r k r q t k y

did not have a h is to ry o f coinage debasement.

In Rome, the experience was qu l te different. Two hundred years before the

pirnic wars, t he copper coinage o f the Roman Empire was debased, and two

hundred years thereafter, both si lver and copper were debased by mint ing coins

wi th an Increased propotion o f alloys. W i t h the In t roduct ion of go ld as a p a r t

of coinage b y Augustus in about 30 BC till the decline o f the empire, the re was a

succession o f debasement and inflation.

2.1.2. I n f l a t i o n a n d War - A 'Sine Qua non' ?

T h e o r i g i n of t h e Pr ice Revolut ion of t he 16 th a n d ea r l y 17 th cen tu r i es

h a d been a m a t t e r of con t rove rsy among economic historians.. While one

school o f ( t h o u g h t he ld t h a t t h e basic cause was t h e increase in t h e s u p p l y

of g o l d a n d s i l v e r f rom' the Spanish colonies of t h e New World, t h e o t h e r

h e l d t h a t t h e i r i f la t ion was caused by non-monetary- factors,. y j t i r t i cu la r l y by

t h e increased demand f o r Spanish e x p o r t s

Many per iods of s h a r p l y r i s i n g p r i ces have been connected w i t h t h e

increased demand f o r resources r e s u l t i n g f rom wars: t h e b e g i n n i n g o f

t h e H u n d r e d years' war (1327);the Eng l i sh C i v i l War (1642 -'48); t h e War

w i t h France [ I689 - 971; t h e w a r o f Spanish succession (1701 - 13); t h e

seven years t War (1793 - 1SOb); t h e Crimean w a r (1854 - 56); t h e B o e r

War (1899 - 79021 ; t h e F i r s t Wor ld W a r (1939 - 451, t h e Korean War

(1950 - 53J a n d t h e Vietnam War, (Heichclheim, 1968; C r i f f i t h , 1976).

D u r i n g t h e Napoleonic Wars, p r i ces rose very sharply. Between 1793 a n d

1813 t h e y mare t h a n doub led and over t he two years, 1799 - 1801, p r i ces

rose by more t h a n fifty percent. Between 1914 a n d 1918, p r i c e s more t h a n

doub led a n d by 1920, t h e y t r ip led . Between 1939 a n d 1941 a t t h e beginning

a t t h e b e g i n n i n g o f t h e Second World War, t h e r e was a f u r t h e r r a p i d b o u t

o f i n f l a t i on as t h e p r i c e level n e a r l y doubled.

One fac t wh ich emerges f rom t h e s t u d y o f behav iour of p r i ces over s u c h a

l o n g p e r i o d o f time, is t h e increased magn i tude o f t h e p resen t i n f l a t i o n

by con t ras t w i t h ear l ier ones. D u r i n g Henry V l l l ' s Great Debasement

(1548 - 51), t h e r a t e o f in f la t ion averaged n e a r l y t h i r t y p e r c e n t ( G r i f f i t h ,

1976).

Ano the r i n t e r e s t i n g fea ture o f p r i ces in European count r ies up t o t h e 19th

C e n t u r y a n d of Europe a n d America since t h e n has been t h e coinc idence

in t im ing o f t h e major per iods of r i s i n g pr ices. In t h e h a l f c e n t u r y be fore

t h e Napoleonic Wars, p r ices rose g radua l l y [abou t one pe rcen t p e r annurn)

About AD214, t h e denan'us.: had approximately a f o r t y percent s i l ve r content.

In the same year, Emp&-or Caracella replaced it as the means of payment by

a double denarius which was only one a ha l f times t h e value o f a s ingle denar ius

(~eichi$lhe)m,1968).

Another indicator o f t he d i f ferent rates o f inf lat ion in Greece and Rome was t h e

d i f ferent levels o f in terest on normal loans (Gr i f f i th , 1976; Brown and Darby,

1985). In Greece, t he interest ra te rose from a level o f 4 percent in 550 BC

t o 6 percent and remained v i r tua l ly constant till about 50 BC.

In the Roman Empire, the interest ra te rose from a level o f 4 percent in AD50,

t o over 12 percent In ADZSO. These variable rates, were not inconnected w i th

qu i te d i f ferent under l y ing t rends in the rates o f inf lat ion. (Gr i f f i t h , 1976;

Rostow, 19781.

Following t he decline o f the Roman Empire, Europe sank in to t h e Dark Ages.

The tmpi re dis integrated i n t o a set o f barbar ian kingdoms which - invaded .and

p lundered each other. A t th is time, l i t t l e was known about t he behaviour o f

wages, prices o r interest rates.

From mid-thir teenth century, a number of features o f B r i t i sh in f la t ion came to

the open [Brown and Hopklns, 1956). Wen- two long periods, each approximately

one hundred and t h i r t y years (1380 - 1510 and 1630 - ?760), the re was a

remarkable s tab i l i ty o f the pr ice level. Throughout these per iods however,

t he p r i ce level did no t remain the same from year to year. Two o ther perlods,

1270 - 1380 and 1815 to 1914, intervening pr ice fluctuations were not iced than

a t the extremes. In the f i r s t o f these periods, t he re were rap id inf lat ions

associated w i t h the misgovernment of Edward 11; the outbreak of t he hundred

years War; the Black Death o f 1348 - 49 and the per iod immediately preceding

the Peasants' Revolt of 1381. Each o f these was followed by per iods o f deflat lon

which were sometimes severe.

For instance, between 1284 and 1289, 1370 and 7379, the p r i ce level fe l l by

near ly one half, In the second, of these periods, there were long per iods o f

fa l l ing p r i ces fol lowed by s h o r t per iods of f a i r l y sha rp p r i c e increases.

T h e p r i c e Revo lu t ion o f T u d o r a n d ea r l y Stuar t p e r i o d (1500 - 1650) reco rded

small p r i ces increases o f n o more than 2 percent p e r annum. (Heichelheim,

19683 . Agalns t t he backd rop o f p r i ce s tab i l i t y o f t h e 14th a n d 15 th Centur ies

it was a substant fA l i Increase. 8y the 1550's the average level o f a g r i c u l t u r a l

p r i ces was about two a n d 8 h a l f times t h e level o f f o r t y years prev ious ly .

Even i n d u s t r i a l p r i ces wh ich rose less rap ld l y t h a n ag r i cu l tu ra l p r i ces were in th

1550'6 - n i n e t y f i v e pe rcen t above t h e level of twen ty years ear l ier . T h e most

r a p i d a n d notor ious In f la t ion of t h i s pe r iod occurred between mid 1542 a n d mid 15

when H e n r y V I I ! a n d h l s son, Edward V I c a r r i e d o u t a substant ia l debasement o'

t h e gold a n d s i l v e r coinage, l a rge ly because of t he f i sca l p ressures t o wh ich

t h e y were subject. Over these n ine years, t h e money s u p p l y more t h a n double

a n d p r i ces rose by about s i x t y - f i ve percent.

Vals'h (1982) also r e p o r t e d t h a t the metall ic i n f l a t i on wh ich fol lowed t h e

d i scove ry o f America const i tu ted one o f t h e most impor tan t instances o f infat t ion

In h i s to ry . He observed that ' w i th t h e adoption o f paper money towards t h e ,

e n d o f t h e 17th C e n t u r y in t h e Un i ted States o f America a n d France, in f la t lon

began to occur a t regu la r Intervals. In 1775, t he USA exper ienced substant ia l

in f la t ion due t o t h e issue o f continental dol lars b y t h e government t o f inance

t h e War o f independence CTUttle and Perry, 7970) .

T h e d i scove ry of gold crlshes In Australia, Alaska, South A f r i ca a n d t h e Yukon

resu l ted in inf lat ion, The hyper - in f la t ion that occured Fn Germany In about 192:

( C h u a n d Feltenstein, 1977; Vaish , 1982) was the wors t in l i v i n g memory. In

Canada, r a p i d i n f l a t i on occured during 1914 t o 1920 a n d between 1947 e n d 1948.

T h e r e occured a r e t u o n t o double digit ln f la t fon In 1951, when N o r t h American

economy became o v e r st imulated b y the demands o f t h e Korean War, In t h e

subsequent f i f teen year per iod up to 1965, the Canadian economy [ f r o m 1966

t o 19761 saw t h e average p r i c e increase by 4 percent p e r annum.

inf lat ionary wi th inf lat ion averaging near ly three percent in Great B r i t a i n and j u ~

ove r three percent in the United States and Germany.

The f i r s t half o f the 19th Century was a general per lod of deflation, w i th pr ices

fa l l ing in Br i ta in between 1815 and 1850, and in the United States o f America b y

average of jus t over two percent, (Tuttle and Perry, 1970); in Cermany b y nearll

two percent and in France, b y one percent. The per iod 1850-73 was a per iod o f

r i s i ng pr ices followed, till the end of the cent rury , by fal l ing prices. The lnflat

before and during the War was qu i te general a l though t h e per iod immediately

following, when there was a r e t u r n t o f loating exchange rates, was no t= Some

countr ies notably Austria, Germany, Hungary, Poland and Russia experienced

hyper-inflation, while others such as Br i ta in experienced a sharp deflat ion.

Between 1920 and 1922, prices fe l l b y a total o f f i f t y - f i ve percent. The deflat ion

accompanying t he Great Depression was however, general and since t h e end of t h

S e c o n d ! ~ o r l d War, a l l Western Countries have experienced continuous inf la i ton.

In f la t ion accelerated in almost all countries following the Vietnam War.

2 . 2 . Defini t ion o f ln f la t ion

Specialists (Levinson, 1971; Hagger, 1977; Ajayi and Ojo, 1981; Lerner; 1349;

Vaish 1982) are no t qu i te in agreement on a s ingle def l f i i t lon o f the term, :nf lat io

According t o Levinson (1971), it was not possible to approach in f la t ion as a

relat ively homogenous and easily defined phemomenon, identical, in al l periods of

time and In d i f fe ren t economic environments. In th is opinion, in f la t ion has remai

a n indetermlnate, unresolved chapter In economic h is tory .

There seems to b e as many dafin.itions o f inf lat ion as there a re economists IA j ay i

and Ojo, 1981). Levy and Sarnat (1978) described inf lat ion as a substant ia l and

sustained increased in the general level o f prices. Using the reciprocal o f the

I. It in t roduced r a t h e r two variables namely, general p r i ce level o r general

wage level, as t h e thing tha t i s in f la ted a n d

ii. It restr:icted i n f l a t i on t o s i tuat ions in which t h e general output i s incapable

of be ing increased, even Dnthe sho r t run.

A l though a l l t he above meanings of in f la t ion d o hwe something t o recommcmd each,

Hagger (19771 l ns i t ed t h a t tliey were al l too much o f economists def in i t ions, a n d thr

did n o t descr ib. t h e in f la t ion t h a t wor r i ed t h e o r d i n a r y man, and as s u c h was

no t o f in teres t to t h e po l icy makers. In .his book therefore, he d e f i n e d in f l a t i on

much in t h e same way as did Johnson (1972) , by descr ib ing in f la t ion as

I1a s i tua t ion in which there

i s a pers is tent upward

movement in t h e general p r i c e

level, o r in which there cou ld

b e s u c h pers is tent u p w a r d

movement but fo r the presence

o f d i r e c t contro ls over

price1' [Hagger 1977) .

Bal l (1973) had ear l ie r recognized t h e d i f f i c u l t y o f advanc ing a c lear-cut

de f i n i t i on o f inf lat ion, but nonetheless maintained t h a t one cond i t ion wh ich was

necessary f o r a s i tua t ion t o b e descr ibed as i n f l a t i ona ry was t h a t p r l ces nus st

b e r i s i ng . T h e thing w o r t h y o f note in the genera l p r i c e increases during

in f la t ion i s t ha t t h e pr ices o f a l l goods a n d serv ices must n o t b e i nc reas ing by

t h e same propor t ions (Gr i f f i t h , 1976, Levy a n d Sarnat, 1978). T h e impoptant

thing i s tha t although re la t ive pr ices v a r y f o r var ious reasons, t h e average level

o f a l l p r i ces cont inues t o rise, sustainedly. T h e change in p r i ces can b e

def ined as

so t h a t t h e propor t iona l r a t e of in f lat ion i s adopted as a n empir ical measure o f the

ra'te o f in f la t ion thus,

Where Pi = Change in p r i c e

P = Pr ice level o r p r i c e i ndex

t = t ime

Usually, in f la t ion i s measured ove r time per iods t h a t a r e su f f i c ien t ly l o n g t o el imin

a n y bias a r i s i n g f rom s h o r t te rm phenomena.

2.3 T y p e s of In f l a t i on

A p a r t f rom t h e many d e f i n i t i o m o f the term, i n f l a t i on has also been v a r i o u s l y

categorised. Words such as creeping, t r o t t i n g , galloping,rapid, chronic, explosive

runaway a n d hyper, have a l l been used t o descr ibe t h e pace o f t he va r ious

' in f la t ionary tendencies (Gr i f f i t h , 1976; Hanson, , 1 9 7 8 a n d Coxon, 1981). ,

Vaish (1982) h a d descr ibed a sustained almost impercept ib le r i se in p r i c e s o f

about 2 percent p e r annzrrn, ascreeping inf lat ion. ln h i s view th is can be d i s t i n -

gu i shed from gal loping o r hyper- inf lat ion wh ich occu rs when the p r i c e ris,e i s

o f t h e o r d e r o f 50 o r 60 percent , and f rom t r o t t i n g in f la t ion in wh ich t h e p r i c e

r i s e occurs a t intermediates, b r milder sustained p r i c e rises, economists have

used t h e terms, walk ing; running o r run-away in f l a t i on t o descr ibe them. T h e

content ion i s t h a t in t h e case o f walk ing inf lat ion, a sustained p r i c e r i s e may b e

about 8-10 pe rcen t p e r annum, while f o r h ighe r t w o d i g i t s sustained p r i c e rise,

t h e te rm r u n n i n g in f la t ion may be used. Vaish (1982) had said t h a t a l t hough

the re may sometimes b e over lapp ing between these terms, t h e pecu l i a r i t y o f each

r a t e o f p r i ce r i s e just i f ied t h e descr ib ing o f a n y p a r i t i c u l a r s i tuat ion, as such . Diagrampatic d i s t j n c t i o n of these terms revealed t h a t in hyper - in f la t ion ,

c u r r e n c y f l i g h t became SO fantast ical ly h i g h t h a t t h e veloci ty of money in

c i r cu la t i on approaches in f i n i t y .

Pr ice

Rise

Hyper- l nf lat ion . . I . Running /

Walking / Inflat ion

5 10 15

Years

Pr ice

l ndex

Fig 2.1. D i f ferent ia t ing between Inflation Types

(Va ish, 1982, P. 180)

Gr i f f i fh (1976) noted that one paticularly common euphemism for in f la t ion was

deflat ion which i n t he context i t was used, s h ~ u l d describe. ' a situation o'F

increased real ou tpu t in the short r u n p l us a greater ra te o f in f la t ion over the

s l ight ly longer r un . Iii the realm o f fa l l ing prices, dis-inf laiton is used to

re fe r to the reduct ion o r elimination o f inf lat ion and should not be confused wi th

demon which re fe r s to a reduction in the level o f real economic ac t i v i t y in an

economy. A depression should not be confused w i t h inf lat lonary situations.

Hanson (1978) was o f the opinion that a depression existed when unemployment

is high and capi ta l is unused for a substaintial per iod o f time. Less severe

than a depression is a recession, although the term i s of ten used emphemi'stically

f o r the former.

Inf lat ion in an economy Is open when there are no barr iersor controls t o p r i ce

increases. The reverse i s suppressed inf lat ion. In th is case, policies of p r i ce

controls, rat ioning o f essential goods, a re p u t in place, to suppress p r i ce

increases. I t was in th is regard that Florence (1975) observed tha t one obvious

d is t inc t ion between open and repressed/ suppressed inf lat ion i s that in the

former instance, pr ices which enter the p r i ce index are as determined by market

7 1

fo rce whi le in repressed inf lat ion, pr ices a n d wages a r e determined admin is t ra t ive ly

so t h a t t h e i r rea l increase Is a d is tor ted estimate o f t r u e i n f l a t i ona ry pressure .

Suppressed in f l a t i on i s subject t o many Il ls; F i r s t l y it creates many d i f f i c u l t

administ rat ive ' problems. In bad ly managed situations, suppresed in f l a t i on 500n

e r u p t e d a f t e r sometime, resu l t i ng in open inf lat ion.

I n f l a t i ona ry sp i ra ls r e f e r t o wages chasing pr ices a n d p r i ces chas ing wages.

T h e re la t ive ly recent 'Staglation' i s a te rm used t o r e f e r t o a cond i t i on o f

' in f la t ion a n d low g r o w t h in real Cross National product , In t h i s case, Stagnat ion

i s usua l ly coupled w i t h i n f l a t i on [Florence, 1975). l n f l a t i ona ry gap came in vogue

in t h e pos t Second World War years t o descr ibe t h e d i f fe rence between money GNP

a n d full employment CNP, w i t h constant p r i c e level ( B r o w n a n d Coxon 19'76).

T h e o t h e r t ypes o f i n f l a t i on w i t h respect t o cause i s t h e Demand Pu l l I n f l a t i on

Demand Pul l i n f l a t i on theo ry explains t h a t when t h e supp ly o f goods a n d services

fe l l sho r t o f t h e demand f o r them, an excess demand was stimulated. T h i s excess

'demand leads t o comper'itive bidding, which in tu'rn would lead t o high& pr ices.

w h i c h pers ist ing, became in f la t ionary (A jay i a n d Ojo,1981). In t h e v iew o f Hanson

( 1 978), Demand Pul l in f la t ion i s a term used t o descr ibe a n d in f l a t i on main ly induce1

b y excessive demand, because supp ly o f goods a n d services con tan t l y fa i led t o

keep pace w i t h demand. Us ing o u r now famil iar paraphrase a demand pull

i n f l a t i on ex is ted in a s i tua t ion where "too much money was chasing too few good".

Technical ly, it occurs when there was al ready full employment, a n d aggregate

demand expands beyond t h e ou tpu t which can b e supp l ied a t full employenlent

(Means, 1975) .

T h e o t h e r t y p e o r t h e Cost-Push theory o f in f la t ion associated t h e r i s e in pr ices

w i t h p r i o r r i s e in wages a n d other costs. T h e t h e o r y deposes t h a t i n f l a t i on

occu red d u e t o t h e increase in the imput costs. Acco rd ing to t h i s explanat ion,

r a p i d l y r i s i n g wage levels, unaccompanied by cor respond ing increase in labout

p r o d u c t i v i t y became ref lected in h ighe r pr ices. (We shal l examine t h i s la t te r

detai l , subsequent ly ) . 2 2

2.4 Causes of l n f l a t i o n

l n f l a t i on has also been classed w i t h respect t o cause. Causes o f i n 4 a t i o n

a n d in f la t ionary processes cannot genera l ly b e unders tood w i t h o u t r e g a r d

t o expectat ions t h a t a r e en ter ta ined abou t t h e f u t u r e course of pr ices.

B r o w n a n d Da rby (1985) ident i f ied f o u r k i n d s o f i n f l a t i ona ry impuls je~,

namely: Wage impulses, expend i tu re pull, cost-push a n d money-inject ion.

T h e y h a d maintained, whi le examining these impulses, t h a t changes in in te res

r a t e b e used as conf i rmatory evidence o f monetary impulses . Rut ledge 119741 h a d observed t h a t s ince the .Second World War, t h e po l i cy

problems associated w i t h ln f la t ion h a d g i v e n r i s e t o renewed In te res ts in

t h e re la i tonsh ip between t h e r a t e o f i n f l a t i on a n d t h e market r a t e o f in te res t .

T h i s i s exp la ined l a rge l y by t h e fac t t h a t i nves to rs form forecas ts o f

f u t u r e ra tes o f i n f l a t i on wh ich e n t e r as exp lanatory variables, i n t o t h e i r

demand a n d s u p p l y schedules f o r real capital . H i cks (1939) h a d eal-lier

no ted t h a t t h e r e were a na tu ra l r a t e a n d a t r u e money r a t e o f i n t e r e s t

b o t h o f which, h e he ld ,would be i d e t h c a l o n l y if t h e f u t u r e p r i c e s s f

the economists commodity remained the same as spot pr ices. T h i s v iew

is in l ine w i t h t h e Keynesian system wh ich o f ten assumes a cons tan t p r i c e

level o f s t i c k y pr ices. Many economists, p a r t i c u l a r l y t h e m o n e t a ~ i s t s , based

on p rev ious exper iences , had he ld t h a t p rec ise measurement a n d u n d e r -

s tand ing of i n f l a t i o n expectat ions deserve much analys is a n d t h o u g h i .

Accord ing ly , var iables represent ing expected r a t e o f i n f l a t i on have been

i n t roduced i n t o e x i s t i n g theories t o adapt them t o a World o f c h a n g i n g pr ices.

U n t i l t h e Grea t Depression o f t h e in te r -war years a n d t h e publ icat io i? by

Keynes In 1936 of h i s classic analysis o f t he problem o f mass unempl3yment

in advanced cap i ta l i s t economies, t h e accepted explanat ion o f t h e causes

o f i n f l a t i on was t h e Quant i ty theory o f money. In t h i s wise, i n f l a t i o ~ was

expla ined o n l y in monetary terms.

The quant i ty theory has a long and dist inguished h is tory . It was t h e theory o f

Dav id Hume, Adam Smith. David Ricardo, A l f red Marshall, Knu t Wicksell and

I r v i n g Fisher (Gri f f i ths, 1976). This quant i ty theory was or ig ina l ly propounded

to prov ide the theor i t ical basis f o r the observed tendency f o r *p r i ces t o increase .

when the quant i ty o f money was r is ing a t a faster ra te than the product ion of

goods and services. In the original form o f the theory, var iat ions in t he quant i ty

of money and the p r i ce level were said to be proport ionately related.

' elements o f th i s view were set out b y Dav id Hume in h is Essay o f 1.752 (Rotwein

1955) in which it was observed that the p r i ce o f commodities a re always proport ion

e d t o the p lenty o f money and that the high pr i ce o f commodities be a necessary

consequence o f the increase o f gold and si lver. Many 18th and 19th centur ies

wr i ters cont r ibuted to t he discussion o f the quan t i t y theory o f money.

In the late 18th and ear ly 19th centuries, Ricardo (1951) rested the theory again

in the context o f a n international economy, not ing as previous wr i te rs h a d done

the di f ference between the in i t ia l and ultimate ef fects o f an increase in the money

supply. Said Ricardo (1951), "if b y the discovery o f a new mine, b y t he abuse

o f bank ing o r b y any other cause, the quant i ty o f money be great ly increased

i t s ult imate ef fect is always t o raise the pr ices o f commodities in p ropor t ion to

the increased quan t i t y o f money; but there is probably always a n intervial

during which some effect i s aways produced on the ra te o f interest .

By the late T9th Century Knu t Wicksell (Cr i f f i th , 1976) showed t h e way in which

money af fected expendi ture and inturn pr ices under two extreme k i nds o n

monetary systems;

(a) a p u r e cash system in which money was e i ther metal o r else bank deposit

backed b y hundred percent reserves and (b) a pu re cred i t system in wbich

money was bank deposits backed by hundred percent credi t . The d is t inc t ive

feature o f Wicksells contr ibut ion was to show how in a wor ld o f c red i t and

interest rates, a change in the stock o f money affected.

pr ices ind i rect ly by I t s effects on market rates o f interest.

The quant i ty theory reached a high level o f sophistication in the work o f

Irving Fisher. In h i s book, the Purchasing Power o f money, Fisher (1911)

l a i d ou t the quan t i t y theory in terms o f t he now famous quant i ty equation ( o r

equation o f exchange I where

in nhich

M = total Money Stock

V = transactlon velocity o f c i rcu la t ing money (o r

the ra te of turn-over o f money in t he process

o f exchange for goods).

P = Price index o f the aggregate p r i ce level

T = the total number of transactions

(o r quant i ty, Q, o f goods sold).

What th is equation o f exchange d i d was to summarise the pr imary factors that

inf luenced pr ice level determination, namely:

...... P = M V l T = MV/Q. . (2.4)

Within th is framework, Fisher (1911) concluded tha t on the assumptidn tha t

increase In money supply (m) wil l general ly not af fect the veloci ty o f

c i rculat ion (V) o r quan t i t y o f transactions(Q) a t full employment level, the

p r i ce level (PI wil l va r y d i rect ly wi th the quant i ty o f money [MI. In h i s v e r y

words : -

"Money supply is seen as the important causal

...... factor in inf lat ion The normal effects o f a n

increase in the quant i ty o f money i s an exactly

proport ional increase in the general p r i ce level "

(Fisher, 1911).

According t o th is classical economic analysis, inf lat ion occurs when the

quan t i t y of money increases, and comes to a ha l t when the quan t i t y of ,

money becomes stable. To that extent, the ra te o f inf lat ion

wil l depend upon the ra te at which new money was created,that i s upon

demand f o r money.

A s a resu l t o f t h e g rea t depression a n d the revo lu t ion b r o u g h t abou t by

Keynesian ideas; t h e q u a n t i t y t heo ry fe l l i n t o g rea t d i s repu te a n d d isuse

in t h e 1940's a n d 1950's. It was g ra te fu l l y re labi l i ta ted d u e t o t h e work of

Mi l toh Fr iedman o f t h e Un ive rs i t y o f Chicago in the Un i ted States o f America,

in what was popu lar ly known as ~ o n e t a r i s h . T h i s thought asser ted tha t t h e

s ign i f i cant determinant o f aggregate spending was t h e supp ly o f money. Thus,

increases in money s u p p l y were seen as the important causal.: f ac to r in

in f l a t i on (Friedman, 1956) . Another, more recent theo ry wh ich attempted t o exp la in t h e o r l g i n o f i n f l a t i on

i s knownas t h e Cost p u s h o r Wages p u s h theo ry o f i n fa l t i on ( w h i c h we s a y

b r i e f l y in t h e conc lud ing paragraphs o f Chapter 2.3). In t h i s theory , g rea t

emphasis i s put on t h e ro le o f t rade unions t o secure increased wages, so

increasing t h e money value o f nat ional income, and w i t h it, in f la t ion .

Most ecwlom i c w r i t e r s a n d decision makers believe tha t t h e cause o f post-war

B r i t i s h inf lat ion, lay, n o t i n excess creation of money, but in t h e monopoly

power o f t rade unions and the i r attempt to ra ise t h e i r share o f wages in t h e

GNP. Said Reginald Maulding, a once chancel lor o f t he B r i t i s h Exchequer,

"The last two decades have

seen p ro found changes, bo th

economic a n d polit ical, in the

whole cap i ta l i s t system. T h e major

change has been a n a r i s ing

consciousness o f t he power o f organized

labour wh ich in a complex modern

economy possesses the power to b r i n g

a n y modern capi ta l is t economy t o

a halt . We see the resu l t o f a l l t h i s

in t h e prob lem o f cost in f la t ion wh ich

has bedevilled th is c o u n t r y fo r many

years ... . T h i s i s a new problem;

it i s a pol i t ica l problem. The o l d

t rad i t iona l economies cannot

beg in to cope w i th i t " (Maulding 1972) .

A r t h u r Burns, then Governor o f the Uni ted St?

sytem, made statements, ap t enough, to descr i t

r v e

stion:-

He said,

"The ru les o f econor;lics are no t work ing in

qu i te t he same way as they used to, Despite

extensive unemployment in o u r coun t r y wage

ra te increases have no t moderated. Despite

id le indus t r ia l capacity commodity pr ices

cont inue t o r ise rapidly (Burns 1971) .

Thus, it i s argued t ha t t rade unions are in a posi t ion to demand h igher wages

from the i r employers and put considerable pressure o n governments. Altogether,

the addit ion o f a l l union's successful demands f o r pay r i se may be g rea le r than

the increase in product ion following increase in wages. Under such situations,

pr ices wi l l r ise,

Alternatively, the r i se in wages may be seen as a n increase in costs pf product ion

which i s passed un to consumers b y way of h igher pr ices o f goods and services.

Another version o f th i s cost push theory of inf lat ion i s the p ro f i t - push. In this

case, an oligopolistic o r monopolistic firm induced a p ro f i t margin o r mark-up

designed to of fset any increases in cost of product ion. Th is m a r k - ~ p or p ro f i t

margin becomes a n important stimulus of inf lat ion.

2.4.1 In f la t ion o r Unempfoyment?

No discusslan on the causes o f inf lat ion would be deemed complete wi thout

reference to the relat ionship between inf lat ion and unemployment, r e f e r r d to as thl

Phillip:' Curve. Originated b y Professor A.W. Phil l ips of thelr>r& School of

Economicsand Political Science, the curve traced the existence of a negat ive but

non-linear relat ionship between the percentage increases in wages and the percent;

o f the labour force unemployed.,.

Phi l l ips (1958) also argued that wages would be affected by the ra te a t

which demand for labour was changing and t he ra te o f change o f re ta i l

prices. Thus, i f .one considered a situation in whlch the average level o f

unemployment was the same but in which the demand fo r labour rose rapidly,

we would expect tha t wages would r ise more rapidly.

Shor t l y a f ter the introduct ion o f the phl l l ips curve, it was hai led by most

economists and policy-makers as one of the greatest empirical laws of economics.

The curves appeared to offer a t rade-of f between inf lat ion and unemployment.

Al though in Gr i f f i t h ts (1978) vlew, the trade-off was of ten presented in terms

of a relat ionship between unemployment and the ra te o f p r i ce inf lat ion, ra ther

than wage inf lat ion. To support the existence o f a t rade-of f f rom which

policy-makers can make a choice between inf lat ion and unemployment, Ajayi and

Ojo (7981) opined tha t It was necessary to show that the r a te o f change o f

money wages (o r prices) was a stable funct ion o f unemployment tha t does no t

sh i f t from one per iod to another. If one assumed that pri-ce increases were

equal to wage increases, less p roduc t i v i t y increases, such a cu r ve would be

paral lel to,but below the original phi l l ips relationship b y a n amount e q ~ a l t o the

percentage increase in product iv i ty.

Another reason for the popular i ty o f the .Phillips curve was t ha t it seemed to

have of fered society a range o f choices. Because It was impossible t o achieve

ei ther fu l l employment o r lwfect pr ice stabil i ty, the best that soclety could

do was to move along the !?hillips curve. Here, the choice was less in f la t ion

( t o the r i g h t ) a t the cost o f h igher unemployment o r less unemployment [ t o

the le f t ) a t t he cost o f more inflation. The chosen combination f o r any count ry

depended on i t s previous h is tory o f Inf lat ion and unemployment.

In the late 1960's and early 1970'5, the Phil l ips cu rve was presented wi th a

major challenge as more and more developed capital ist economies became faced

wi th a n experience o f r is ing inf lat ion accompanied b y a h i g h level o f unemploy-

ment [Griffith. 1976; Ajayi and Ojo, 1981). These experiences, to ta l ly

unexpected as they were, led economists t o question, no t only t he s tab i l i t y

o f the Phi l ips relationship, b u t also i t s ve r y existence.

One dissent ing school o f throught he ld that inf lat ion was synonymous w i t h cost

inflation, Th is g r o u p observed that wage inf lat ion and unemployment were

atween the determined b y separate factors and tha t any empirical connection be.

two, was explained by random forces. For instance, wage in f la t ion was said

to be the , resu l t of conflict between labour and capital over the size o f the i r

respective shares in the CNP and of the attempt b y t rade un ion to charge wage

differentials t o the i r own advantage. Secondly, p r i ce inf lat ion was bel ieved

t o depend o n wage increases, d i rect and ind i rect tax r ises and upward

movement in import pr ices (in the Nigeria case, upward movement in fore ign

exchange rates] .

The other schools of thought based the i r explanations o f the perverse behaviour

o f the Phi l ips c u r v e on effects of expectations o f f u t u re pr ice increases on

cu r ren t economic behaviour. The general concensus seemed t o be tha t if trade-

of f existed between un-employment and wage (pr ice) increases, It was on ly in

the shor t run; and that no permanent t rade-of f existed in the long run

between in f la t ion and unemployment as the economic climate was subject to

change, and as there existed market imperfections, thus making the Phi l ips

relationship a shor t - run phenomenon.

Estimating ln f la t ion

An in f la t ionary r i se In prices must be concerned mostly wi th the concept o f the

general p r i ce level. It i s therefore appropr iate to consider r i s i ng pr ices in

terms o f some measure o f the general p r i ce level. Ris ing pr ices must o f

necessity be thought of as reflected in some average o f al l prices, and t h i s

chosen average o f the general pr ice level i s used t o define an inf lat ionary

situation.

Three main problems thus emerge in an e f f o r t t o measure the ra te of inf lat ion

namely;

1 . Choice of an index o f prices t o represent the genera1 pr ice level.

2 . Measuring the extent o f the upward movement in the chosen index ove r a

specif ied per iod o f time, and

3 . measuring variat ions in the speed o f the upward movement in the chosen indc

over the specif ied time period,

The general p r i ce level must be regarded as a n average p r i ce o f some klnd, which

then raises the quest ion as t o what pr ices t o use and how they are t o b e summed

together. In t r y i n g t o measureinflatiorione(of the man problems remains t h a t o f

choosing the p r i ce index which would represent the general pr ice level. Accordin

t o G r i f f i t h (1976), the ra te o f inf lat ion in a modern economy was measured by Ind

numbers. The Austral ian possibilit ies (Haggs, 1977) come qu i te handy in t r y i n g

to determine an appropr iate measure of a r ise in the general pr ice level. These

possibilit ies, including the i r merits and demerits consist--of:

i. The Consumer Price lndex (CPI)

ii. Some component o f the CPI

... III The Wholesale Pr ice lndex (WPI)

v lmpl ic i t Deflator o f some Category of the Gross National Expendi ture ( G N E )

vi . lmpl ic i t Deflator o f the Non-farm GNP a t Cost.

i. The consumer p r i ce lndex (CPI] . Th is i s intended to measure only var iat io

in the retai l pr ices o f those goods and services which at t rac t a substaint ia l

po r t ion o f the aggregate expendi ture o f wage errrers ; It Cove6 a l l important

raw foods and a l l commodities whose pr ices are subject to s igni f lcant var iat io

th rough fiscal action. The CPI i s no t however comprehensive as it c'oes no t

cover al l foods and commodities.

ii. Some component of the CPI

In th is case, instead of using the CPI, one could use one o f the f i ve compo!:

indexes from which theCPl is bu i l t up, namely :-

the indexes f o r food, c lothing and draper.^, housing, house-hold supplies

and equipment and miscellaneous. Like the CPI, these components lack

comprehensiveness.

iii. The Wholesale Pr ice lndex

While the CPI represent retai l pr ice indexes, the WPI considers Wholesale

p r i ce indexes o f materials used in house-building o r the index o f materials

used In bui ld ing, o ther than house building. Again the WPI i s no t

comprehensive.

iv. T h e lrnplidt Def lator of t he GNP

Thls i s not, s t r i c t l y speakitkg , a p r i ce index, I t Is calculated f o r any

quar te r b y d iv id ing the GNP in cur ren t pr ices f o r that qua r t e r b y the

CNP in constant pr ices f o r t he same period. Al though it i s no t a gennuine pd

index, It can specifically be thought o f as one re la t ing t o a l l good:; and

servlces comprising GNP.

v. The Impl ic i t Deflator o f Some Category o f GNE

The GNE def lator measures the movement in the general p r i ce level o f some

component o f C N E f o r instance the implicit deflator o f personal con!;umptlon

expendi ture. It on ly lacks the advantages o f the GNP def lator and also

shares its disadvantages.

vi . The Impl ic i t def lator fo r non-farm CNP a t Cost

Th l s p r i ce index is obtained f o r any g iven quar te r by d i v i d i ng t he f i gu re

fo r non-farm CNP a t factor cost, in terms o f cu r ren t pr ices by the f i gu re

fo r non-farm GNP at constant prices. Th is lndex al though satisfact9t-y in

some respects, is no t total ly acceptable.

In a b i d t o determining which o f these indexes was the most appropr iate, Hagger

(1971) approached the problem b y f i r s t o f a l l l i s t l ng the character ist ics o f a pr ice

index ideal fo r measuring inflation. The f i r s t characterist ic requi res tha t the

index relate to. t h e commodities produced within the economy.

o r economies for which inf lat ion i s being measured. The second requi res tha t the

index be comprehensive w i th respect t o the goods and services produced w i th in

the economy. Th i rd ly , the index should take proper account o f Improvements in

the qual i ty o f t h e various commodities covered by the Index. The f o u r t h and final

character ist ic requi res that the Ideal index should no t b e affected by temporary

p r i ce increases l ike ly t o reverse in the immediate future.

Af ter th is review, Hagger (1971) observed t ha t none of the l is ted s i x indexes was

en t i re l y sat isfactory and that in any actual situation, serial p r i ce indexes could b e

legitimately used t o measure inf lat ion.Gri f f i th (1976) in apparent agreement had

ear l ier noted t ha t al l o f these pr ices indexes "have cer ta in biases, contain defects

and over shor t per iods o f time, these indexes behave qu i te d i f ferent ly" . Often, in

practise, during inf lat ionary periods, these indexes moved closely together.

With time, pract ise and experience it became obvlous tha t the most convenient mode

of represent ing a single p r i ce over tlme, in many respects, was to. express it as a

percentage o f i t s value in some g iven year. Thus, if a par t icu lar p r i ce was g iven

the number 100, it i s implied that It was 100 per cent o f the p r i ce obtaining i n

that g i ven base year. For instance, if the value was 100 in 19-X and 115 In the

year 19-Y, then it could b e said tha t the p r i ce had r isen 15 pe r cent between the

years 19-X and 19 - Y.

Ba,ll. (1973) r i g h t l y noted that w i th the general p r i ce level, complications arose

because it was a ref lect ion of the behaviour o f many pr ices and some way must be

found to add them up. However, since all pr ices were no t equally important, it

was usual ly felt necessary to represent the general p r i v e level as a weighted

average, so tha t the movement of an ind iv idua l pr ice cont r ibuted t o the movement

o f the whole in propor t ion to the importance wi th which i t was regarded.

In theory, matters got complicated b y the fact that the choice ofweights was no t

general ly unique. While d i f ferent sets o f weights lead to d i f ferent numerical

assertions about how much the general p r i ce level has a altered between two ~ o i n t s

3 4

In time, in practise, t h i s i s ' no t unduely t'estrictive. The reason i s because

even the d i f f e ren t methods of weighting o f ten had t i t t le ef fect on t he b road

. qual i tat ive coirclusions rcachcd about p r i ce behaviours.

2.6 Inf lat ion : T h e Niger ian Experience

In Nigeria, the index o f pr ices has been continuously on the increase :since

1960, al though ths p r i c= increases since 11970 have ,been of more significance.

The World Bank C o u n t r y Ec~nornic ~ i ~ o t - t o f 1979 had A that in: t h e two years ,

endirig December 1971, the money supply in Nigeria ' incieased b y 52 p e r cent.

The report. bttmed some o f the increases o n the remonltization in the t h e n Eastern

States o f N iger ia a f t e r the Civ i l War, most o f whlch however stemmed f rom

government's rel iance o n shor t t e r n bor tow ing from the bank ing 'system and

thus con t r ibu ted to the rap id rate o f u rban inf lat ion.

Ajayi and 'Ojo (1982) had it that the r a te o f 1nflatio.n between 1969 a n d 1970 was

about 1.0 p e r cent, but that it rose immediately a f te r the c i v i l war in 1970 tp

about It4 p e r cent, and thence to. 16.1 p e r cent in 1971, mainly a t t r i bu tab le to

food pr ices whlch increased b y 24 p e r cent and 27 per cent respect lvely.

Import l iberal izat ion measures o f 1971 eased demand pressure on manufactured

goods b u t ant i - in f la t ionary effects had l i t t l e ef fect on food prices. A f t e r a l u l l

between 1972 a n f 1973, the consumer p r i ce index rose again from 213.6 in 1974

to 286.4 in 1975 (Base 1965 = 100) ,an Increase in inf lat ion ra te o f 34.0 p e r cent.

N w a n k w o [ 1 9 0 0 ) was of thc oplnlon that t f ~ c per iod sincc 1374 could bc regarded

as inf lat ion era. He said that although in f la t ion had been plaguing t h e Niger ian

economy well before then, it got so serious tha t in 1974 the then Head o f State

described the phenomenon as Public Enemy Number 1. Nwankwo ( i b i d ) t ~ e n t - P ---

ahead to d iv ide the inf lat ion era in to two. The f i r s t per iod o f T974 t o 1976 was

characterised b y the short- l ived oil boom which created the euphoria t ha l a l l was

well w i th the economy as there was a ve r y healthy balance o f payment pclsition

and a considerably improved Government revenue position. Dur ing t h i s

period, the bank ing system had an unsual

excess l i qu id i t y as a resul t of the heavy spending by government, o f i t s o i l

revenues. Terminat ing this period was the launching o f the T h i r d Nil t ional

Development Plan invo lv ing a planned expendi ture o f a whopping 30 b i l l ion

naira. Th is set t ing o f the f i r s t period, launched what NwankwoC1980) referrec

t o as the second era, from 1976, a time in which t he balance o f payments r a n

i n t o huge def ic i ts which have recalc i t rant ly persisted, till date.

As the prospects f o r o i l production and sales became unfavourable, governmen

revenues slumped and a period o f aus te r i t y and acute inf lat ion whose end

remained unforeseeable set in.

Ciroma (1976) as governor o f the Central Bank o f Nigeria (CBN) blamed the

acute Inf lat ionary pressures at the time, on excess l i qu id i t y in the bank ing

system. In h is opinion, the banks had substantial funds f o r which they were

no t finding as much investment out let as they would wish. Among the several

o ther factors tha t under l ined the in f la t ion included insuff ic ient product ion f o r

t he domestic economic market, added to a n inadequate physical capacity t o

augment th rough importation,compounded, as it were, b y p o r t congestion al l

o f which together did severe damage to the economy.

l nf la t ion pressures intensif ied during 1983 following the general scarc i ty of

consumer goods which was made worse b y hoarding and the sharp increase i n

the money supply situation. There was a rap id r ise in consumer pr ices as

revealed b y the Federal Office o f Statist ics (FOS) all-item Composite (?PI

which averaged 328.5 (base 1975 = 100) an increase o f 23.2 p e r cen l above

the prev ious year's level. The major factors responsible fo r the high pr ices

was the fal l in food production and the d rop in importation due t o import

res t r ic t ions and low foreign exd7ange.

Ahmed (1986), seemingly towing the l ine o f Ciroma (1986) observed tha t the

oi l g l u t o f the late 1970's and ear ly 1980's resul ted i n a sharp decl ine in the

Federal and State governments' revenues which was not matched by a corres-

ponding reduct ion in publ ic sector expenditures. Consequently, la rge

b u d g e t a r y de f ic i ts -red, f inanced mainly by t h e b a n k i n g system. T h i s

cons t i t u ted substant ia l l y t o excess demand p ressu re in t h e economy a n d t h e

accelerat ion in t h e r a t e o f in f la i ton from 9.9 pe rcen t in 1980 t o 39.6 percen t .

in 1984.

It was also r e p o r t e d (CBN Annua l Report, k c . 198Y) t h a t s u p p l y sic'e factors

were dominant i n r~exe r t i ng u p w a r d pressures o n p r i c e s In 1984. Severe shortages

in consumer goods a n d serv ices markets, caused mainly by low ' leve l domestic

ou tpu t , h o a r d i n g act iv i t ies; l ong cha in d i s t r i b u t i o n ne tworks a n d i m p o r t

res t r i c t ions , l e d t o t h e h i $ b s t in f la t ion r a t e as t h e al l- i tem composite CPI rose

f rom 328.5 in 1983 t o 458.4 in 1984 (Base 1975 = 100) . O t h e r c o n t r i b u t o r y

fac tors blamed f o r t h i s s t r o n g u p w a r d movement o f p r i c e s were r e d u c e d level

o f impor t s o f complementary commodities a n d Inadequate storage fac i l i t ies.

T h e i n f l a t i ona ry p ressu res wh ich reached a peak in 1984 subs ided cons iderab ly

in 1985. Foli lowing t h e f igures pub l ished by t h e FOS (CBN Annua l Repor t ,

December 1985) , t h e r a t e o f i n f l a t i on decl ined s h a r p l y t o 8.5 p e r c e n t in 1985

f rom a peak 39.6 p e r c e n t in 1984. Al though t h e a l l i tem composite CPI s t i l l

mainta ined a n u p w a r d t r e n d (1984 CPI = 458.4, 1955 CPI = 483.7) , t h e r a t e

o f domestic p r i c e increase decelerated cons iderab ly in 1985 ,in re la t i on to t h e

p rev ious year. Compared w i t h t h e 39.6 percen t i n f l a t i on r a t e in 1984, t h e CPI

increase in 1985 was o n l y 5.5 percent . T h i s re la t ive r e d u c t i o n was r e p ~ t e d

t o b e a t t r i b u t a b l e main ly t o a n Improved domestic s u p p l y s i t ua t i on a n d t h e

r e s t r a i n t o n expans ion o f aggregate demand, especial ly in areas o f government

spending. These v iews were also expressed by t h e U n t e d B a n k f o r A f r i ca

Chairman (Bus iness Times Monday 5 t h May, 1986) in h i s Annual R e p o r t f o r t h e

yea r ended Dec. 1985. He ascr ibed t h e re la t i ve dec l ine in in f l a t i on r a t e

between 1984 a n d 1985 t o increased domestic p roduc t i on in t h e ag r i cu l t u r3e a n d

manufac tur ing sectors , assisted b y low levels o f monetary expansion.

Looking a t t h e f i g u r e s quoted by Ahmed (1985), government cap i ta l expend i tu re

in 1986 was 5445.9 mi l l ion naira, decreasing f rom 6,096.4 mil l ion n a i r a in 1985.

Correspondingly,data suppl ied by the FOS (CBN Annua l Repor t o f DEc. 1986)

showed t h a t i n f l a t i on moderated in 1986, d u e la rge ly t o improved food supp ly ,

A t 509.7 (Base: 1975 = loo), the all-item CPI in 1986 fo r a l l income g r o u p s in

u r 5 a n and r u r a l areas rose by 5.4 percent , compared w i th a n increase o f 5.5

percent in 1985. T h e decl ine again, was a t t r i b u t e d t o t h e increase i n food

p roduc t ion a n d reduc t i on in personal income which severely c u r t a i l e d consumer

demand. Also con t r i bu to ry , was t h e tight monetary and f iscal po l i cy .

2.7. I n f l a t i on a n d Project Evaluation

Wil loughby (19771. observed tha t t h e te rm tevaluationl has tended ' in English,

t o take o n t h e sense o f a re t rospect ive rev iew o f something a t least 01 going.

R o m t h e p o i n t o f v iew o f economic, method, t h e di f ference betweenter:-ante'

(a ~ r i o r ; ) o r lex-post t (a poster ior i ) p ro jec t evaluat ion i s o n l y one o f perspect i \

T h e Central f o c u s o f a n y investment analys is usua l ly invo lves a c ~ m p ~ r i s o n o f

t he s i tuat ion w i t h : ! t k inwstment and tha t w i thout t he investment.

Goodman a n d Love (1979) def ined Project Evaluat ion as the appraisal o f t h e

overal l ab i l i t y o f a pro jec t t o succeed. Such an appraisal i s usua l l y clone by

compar ing t h e expected benef i t from t h e project , w i th the amount o f resources

t o b e committed in execut lng the project . A l though th i s sounds v e r y much

l i k e an 'a!prior i lproject evaluation, t he o n l y fea ture considered pecu l i a r t o

ex-post analys is i s t h a t quoted f inancia l f i g u r e s may need ad jus tment by a p r i c t

index, in o r d e r t o eliminate the ef fects o f Inf lat ion, made appra ten t by a gener?

change in t h e p r i c e level o f goods a n d services. Accord ing t o Wil loughby,

(19771, a charac ters t ic weakness o f expost pro jec t evaluation, from t h e World

Bank's exper ience, i s t ha t at tent ion was usua l l y d r a w n to issues a n d cases

o f p ro jec ts approved f o r t he Banks s u p p o r t u n d e r pa ides t h a t were n o t necessa

s t i l l c u r r e n t . He there fore saw i t as a n " i n t r i n s i c problem o f eva luat ion t o avoi

a n ar id historicisrrlt whi le re ta in ing the ob jec t i v i t y a n d independent v iew po in t

which a re I t s p r imary strengths.. , The implication here i s that i t i s necessary,

a t t he f i r s t instance, and to make more meaningful the c0n ten . t~ o f pro ject

appraisal, to Include in the projectjons, a condi t ion tha t accomodates inf lat ionary

pressures .

Harbergc r il972) d i f f e red sl ight ly wi th t l ~ e s c view when he said that most

discus&ons o f project evaluation ('ex-ante'), note tha t expected p r i ce changes . ,

should b e talcen In to account. What th is sought to 'suggest was t ha t techniques

o f project evaluation' were ready made to accomodate inf lat ion- induced changes in

the general p r i ce levels.

- Olashore ( 1987) apparent ly echoed th is po in t when he observed t h a t Acc:auntants,.

th rough t he ages, have no t been ind i f ferent t o changes in general p r i ce levels. H

maintained that . under t h e subject o f .Account ing fo r inf lat ion, cbnsiderable at tent io

was g iven t o the concept o f changes in specif ic general p r i ce levels. Consequent

upon th is was the formulation o f a series o f guidelines classif ied as Statements.of

Standard Accounting Practises, each o f which endeavoured to reconcile the d.iverge

views o f accoun'tants in repor t ing financial statements. Writing 'on the ef fect of SF

on Accounting Methods and procedures bo th Olashore and Randle ( 1 987) ~ecognisec

tha t the d ive rgen t views inherent in al ternat ive accounting methods. For repor t in !

financial statements would not reflect the impact o f SFEM. Olashore's views:

"Considerable f lex ib i l i ty allowed ind iv idua l f r ims in

t he application o f alternative accounting methods fo r

repor t ing f inancial statements would usual ly no t re f lec t

the impact o f SFEM. One serious impact o f SFEM i s

that o f unbr id led inflation". (Olashore 1987)

Again, Olashore ( 1987 ) observed that the aspect o f accounting repor ts l i ke ly t o

be af fected in the presentation of operational act iv i t ies i n d u d e Valuation o f Assets,

among others. Randle (1987) also had noted tha t another problem which SFEM

created f o r accountants and auditors related to the revaluation o f f ixed assets,

especially plants and machinery. In his opinion, companies were right to sc?ek

to revalue the i r assets in order to reflect the vas t l y increased ( in f la ted?)

replacement costs. St i l l w i th in the SFEM era, Randle ( ib id ) noted t h a t when

it came to stock valuation,while opening stock may have been calculated o n

p r e SFEM histor ical cost,closing stock may be closelyreflectt ive o f pos t SFEM

purchas ing cost. He therefore cautioned that l i ke be always compared w i t h l ike,

since vas t l y d i f fe ren t resul ts could emerge depending o n whether closing stock

i s calculated o n f i rst- In- f i rst-out (FIFO) o r Last-In-First-Out (LIFO) basis.

In essence, wha t 'a l l these point to is to say that one aspect o f a cornpa;?yls

revaluation, most l ike ly t o bring ou t t he effects o f a general p r i ce increase, i s

the aspect o f Assets Valuation.

2.8 In f la t ion and G p i t a l Budget ing

Oneaspect o f business enterpr ise whose siamese twin i s Project Evaluation could

be said t o b e Capital Budget ing .Weston and Brigham (1980) explained Capital

Budget ing to involve the ent i re process o f p lanning expendi tures whose re tu rns

a re expected t o extend beyond one year. They maintained tha t the optimium

Capital budget i s simultaneously determined by the interact ion o f supp ly and

demand forces under conditions o f uncertainty.

Naslund (1971) he ld that the area o f capi ta l budget ing was ve ry large and

d ivers i f ied and that there existed i n l i terature, discussion on the proper.

criterion t o use t o evaluate investment projects. Weingartner (1965 and '19661

approached the problem from various points o f views and came up w i t h a va r ie ty

o f formal techniques. Lorie and Savage (1955) seemed concerned about the

problem o f allocating f i xed funds among a specified set o f investment. projects.

Thei r problem was to set budget cei l ings proper ly and t o determine the discount

rate. Chaines et a l (1959), reformulated the warehouse model o f Kahn (19493

and augmented it w i th financial constraints, thus determing b o t h the b u d ~ e t

constraints and the discount rate inside the model.

Al l i n al l , choices among feasible investment projects der ive d i rect ly from

t h e goals o f t h e firm. T h e d i rec t economic goal o f a p r i v a t e f i rm i s t o maximise

t h e weal th o f t h e f i rm's stockholders [Boness, 1972). In t h i s sense, whatever

inves tment p l a n was good enough. for t h e stockholders, was assumed t o b e good 1

t h e f i rm. In t h i s perspective; t he success ( o r role) o f f inanc ia l management was

o f t e n ~ b s c u r e d by t h e const ra in ts t o .which weal th maximization was subjected.

One s u c h c o n s t r a i n t i s t h a t o f i n f l a t i ona ry pressures.

A l t h o u g h Cap i ta l b u d g e t i n g decisions o f ten i nvo l ved d i scoun t i ng in advance, stocl

p r i c e s a r e a lways in a f lux, such t h a t it 'becomes techn ica l ly impossib le f o r

management t o maximize t h e p r i ce o f common s tock w i thou t i d e n t i f y i n g t h e rea l

in f luence o f non-corporate forces o n common s tock values.

T h a t i n f l a t i o n was o n e s u c h fac tor was imp l ied by Holsen (19781 when he said

that t h e f i r s t thing usua l l y tione b y t h e Wor ld Bank when ana lyz ing a c o u n t r y ' s

c r e d i t wo r th iness f o r k i nk loan was t o ascer ta in t h e e x t e n t t o w h i c h p g b l i c

e x p e n d i t u r e was f inanced by pub l i c sector savings, g r a n t i n g somk i n t e r n a l

b o r r o w i n g f r o m non- inf la t ionary sou-rces. T h e impression deduceable f r o m t h i s

asser t ion i s t h a t in f la t ionary pressures h a d t h e capaci ty t o reduce the monetary

va lue of inves tment p ro jec t s . Bonnes (1972) h a d said t h a t t he p r i m a r y subject in Capi ta l B u d g e t i n g i s tnves t -

ment Decis ion process. Bierman a n d smidt (1980) pos i ted t h a t in eva lua t i ng

.Capital b u d g e t i n g decisions, a businessman mus t consider n o t o n l y t h e possib le

e f fec t s o f in f la t ion , but also the e f fec t of l ong run t r e n d s in t h e r e l a t i v e pr ices

o f h i s p roduc ts . Generally, a r i s e in p r i c e level b r i n g s about a d r o p in t h e

p u r c h a s i n g power o f money, in th i s case t h e Naira. I t t h u s I s impor tan t t o

measure t h e cost a n d benef i ts o f a n ivnes tment in terms of Na i ra o f cons tant

p u r c h a s i n g power (Randle, 1987).

We h a d ear l ie r seen t h a t t h e fundamental mechanism o f analys is in eva lua t i ng

inves tment p ro jec ts was t h e Net Present va lue (NPV) Formular. In u s i n g t h e

NPV method o f Pro jec t Evaluation, t h e app rop r ia te Cost o f Capi ta l in a n y g i v e n

p e r i o d i s t h a t r a t e o f i n t e r e s t which when u s e d t o d iscount t h e expec ted va lue o f

t h e f i r m a t t h e e n d o f t h e pe r iod t o t h e beg inn ing , exac t ly equates t h e d iscount

expected e n d i n g va lue w i t h t h e g i ven b e g i n n i n g value. B y accept ing t h e p ro jec t s

w i t h pos i t i ve NPV values, t h e expectat ion i s t h a t t h e PV o f t h e i nves tmen t is

maximized, a n d th is ; ce te r i s paribus; implements t h e goals o f t h e f i rm. Un fo r tuna t l

however, a l l t h i n g s a r e n e v e r always equal. F o r one thing, t h e cos t o f cap l ta l i s

n o t necessar i ly cons tan t o v e r time periods.

Nonetheless, Boness (1972) h e l d tha t t h i s PV method o f eva lua t ing p r i v a t e Investme'

proposals c a n fo rmal ly b e c a r r i e d o v e r i n t o t h e ana lys is o f p u b l i c investments,althou

d l f f i cv l t ies pecu l ia r t o p u b l i c sector investments wou ld arise; re la ted main ly, t o t h e

non -p ro f i t n a t u r e o f col lect ive governmental act iv i t ies, a n d t o t h e non-marketable

n a t u r e o f p u b l i c goods. Because b o t h bene f i t s a n d costs o f many p u b l i c investment

a r e multi-dimensional, t h e y a re inappropr ia te subjects f o r a s t r a i g h t f o r w a r d evalua

t i o n in terms o f p r e s e n t values o f economic pr ices.

A l t h o u g h Capi ta l B u d g e t i n g decisions may b e u s i n g e i ther money o r rea l f low,

Bierman a n d Smidt (1980) noted tha t t h e r e may s t i l l b e d i f fe rences in es t imat ing

t h e necessary imputs, t h e costs a n d benef i ts o f a n investment p ro jec t . T h e y

maintained t h a t if revenues or costs were main ly determined by marke t forces in

t h e pe r iod in w h i c h t h e ou t l ays were made, o r e revenues received, t h a n estimates

in terms o f money f lows. O n t h e o t h e r hand, t h e y he ld t h a t i f f u t u r e costs a n d

revenues were determined by immediate decisions, by income cons idera t ions o r by

l o n g te rm con t rac tua l relat ionships, estimates in terms o f money f lows were l i k e l y tc

b e more accurate.

T o conve r t money values t o real values Bierman a n d Smidt (1980) chose t o d i v i d e

t h e monetary va lue by a n appropr ia te p r i c e i ndex re lat ive. T h e y supposecl an

investment t h a t p romised t o r e t u r n W l O O p e r year, f o r t h ree consecut ive years a n d

whose cash proceeds

measured in money values, were certain. Given that the discount ra te was 9 percen

the PV o f the monetary value was W 75.91. If it were assumed that the p r i ce index

(PI1 was 140 f o r t he cu r ren t year, 145.60 for t he nex t year and 151.42 the followir

year; and i f money values were to be converted to real values in al l th ree years in

terms o f the c u r r e n t year's pr ice level, then a p r i ce index relat ive must be

constructed fo r each o f t he three years.

The P I relat ive was the ra t io o f two p r i ce index values in which the numerator

was t he value o f t he P I fo r the cu r ren t year in which the cash flows occur red

and the denominator was the P1 for the base period. Having obtained these P I

relatives, money values were then converted t o real values, f o r a g iven period,

b y dividing the money value fo r the per iod by the P1 relat ive f o r that period.

Using the hypothet ical case above, Bierman and Smidt (1980) calculated t he P1

relat ive t o be 1401140 = 1 .OO f o r the cu r ren t period; 145.61140 = 1 .O4 f o r the

nex t year and 151.42/140 = 1 .O8 f o r t h e following year. To conver t money values

t o real values, for any given period,t hey went ahead t o d iv ide the money values

fo r the per iod by the P1 relative fo r tha t period. Thence, the .real [R ) o f

W100 t o be received in the base year was found be 10011.0 = R W 100/1.38 = RPI

92 -46.

Using th is premise, Blerman and Surd t (1 980) analyzed the inv-estment out lays

o f a f ic t i t ious company, under d i f ferent inf lat ionary any conditions, over ir

f ive year period. After the analysis, they came to the conclusion tha t real

cash flows (Cu r ren t Purchasing Power), were considerably d i f fe ren t from

money flows, In times o f inflation,

On t he use o f cu r ren t purchasing power, Rockley (1981) d l d observe t ha t the

Accounting S t a n d a r d Steering Committee of the Uni ted Kingdom had recommended

that conventional h istor ic costs be adjusted by a conversion index which

reflected a measured change i n the value of the monetaryunit'ln-whkh aoclcr~nts Wet-

expressea. I nrs measured change in the purchasing power o f the monetary unit

was to be taken from the movements in the consumer p r i ce index, calculated, in

the Nigerian case, b y the Federal Off ice o f Statistics.

2.9. Why Worry about In f la t ion?

Nagger (1977) did say tha t one main reason in trying t o prevent a pers is tent upward

movement in the general p r i ce level was tha t it led t o a red is t r ibut ion o f real income

which was a r b i t r a r y and which therefore may well be socially un just people whose

money income rose less rap id ly than the general p r i ce level, lost re la t ive ly in inflat ia

while those whose money rose more rapidly than t h e p r i ce levels, gained d u r i n g

inflation.

Duesenberry (19771 observed that losers in inf lat ion were more l i ke ly t o include

pensioners academics and other c i v i l servants w i t h a f i xed income. He insisted tha t

the red is t r ibut ive effects o f inf lat ion were no t conf ined to real income and said t h a t

people o r ins t i tu t ions whose wealth comprised mainly o f assets o f a f i xed pFesented

one who wished t o save wi th a d i f f i cu l t dilemma. I f the person s t i l l had something tc

save, he r a n the r i s k tha t inf lat ion would reduce t h e real value b f these sums to t h e

extent that he would find it di f f icul t to meet the needs f o r which the sav ing had bee

set out.

For government, inf lat ion could cause a balance o f payment (A jay i and Ojo, 1981).

Th is was particularly t r ue for countries in which forelgn trade palyed a major role

in the economy, because inf lat ion could weaken the balance o f payment posi t ion b y

st imulating imports and rest r ic t ing exports. Newmark (1977) was of the opinion t h a t

s t r i k i ng a balance between budgetary losses and ga ins from in f la t ionary proc:esses

was a ve r y d i f f i cu l t and complicated task, more so as resul ts o f theor i t ical and

emprical studies on these issues differed considerably. He nonetheless concluded

that wi th respect t o publ ic revenues, inflation-Induced losses were conf ined to

categories which in general were not ve r y important. In the f ie ld o f t a x e s , ~ p v e m m i

resu l ted on ly f rom taxes which were of smalf budge ta ry relevance, wh i le

progress ive persona l taxes prov ided governments w i t h considerable ga ins due t o

inf lat ion. On t h e exper id i ture side, Newmark (1977) noted tha t governmental

losses were combined w i t h gove.rnment gains a n d t h a t i t was v e r y difficult td clearl '

specify t h e co r rec t balance.

Some economists h a d a rgued that some form o f in f la t ion was inevi table f o r growth,

a l though Friedman (19731 reported tha t many count r ies h a d In f la t ion w i thou t g rowth

T h e general impression though had always been t h a t in f la t ion ' w a s e v i l a n d should

b e avoided. In t h e opin ion o f Kiein ( l 9 7 7 ) , t h e pub l i c seem to r e g a r d in f la t ion

as 'per set evi l . As had earl ier been observed, t h e greatest object ions l o inf lat ion

arose because o f i t s impact on wealth and income d is t r ibu t ion . D u r i n g inf lat ion,

t he grea,test losers were,usual ly people o f f i xed incomes; salary earners, pensioners

and wealth owners whose wealth was heav i ly dependent o n fixed-income assests.

T h e s i tuat ion seem s l i g h t l y improved when we considered fixed-income securi t ies.

T h e reason beh ind t h i s i s because, in add i t ion to a premium to, cover t h e f inancia l

r i s k of default, t h e y ie lds on f i xed Income secur i t ies also ref lect the r i s k o f

general r i se In consumer prices d u r i n g t h e life-time o f the contract . Such a

premium became necessary since credi tors (bond-holders) su f fe r a real economic 10s:

when consumer p r i ces r ise, Inf lat ion reduced the purchas ing power o f t h e f ixed

nominal amounts ( in teres t and r e t u r n on pr inc ipa1)which a bond-holder i s en t i t led

t o receive; t hus necessistat ing the need f o r a n addit ional premium t h a t wou ld induct

such ho lder t o g i v e up present money in r e t u r n fo r a promise t o receive a fixed

amount o f f u t u r e money.

Evident ly , when uncer ta in t y regarding t h e purchas ing power o f money becomes ver:

great, investors may become unwi l l ing t o acqu i re f i xed income-bearing secur i t ies

unless a n d exp l i c i t purchas ing power guarantee was added to t h e cont rac t . Thus

the world-wide i n f l a t i on during and a f te r t h e Second World-Warled a number of

countr ies to i n t roduce investments whose in te res t a n d l o r p r i nc ipa l were l i n k e d t o

vavious p r i c e indexes. In addition, purchas ing power guarantees, o r escalator

clause were be ing inc luded in wage the rnonetory unit in the which accounts were

cont rac ts a n d pension contracts in t h e Uni ted States a n d many European

Count r ies [Sarnat , 1973).

Bonowers ga ined in inf lat ionary per iods since a t t h e t ime t h e loan was due, t h e

rea l va lue o f money used t o repay t h e loan would b e less than t h e rea l value

when t h e money was borrowed.

T h e ro le o f pu rchas ing power r i s k c a n be c lar i f ied by u s i n g t h e known mdist inct ion

between t h e lmoney a n d 'real' rates o f interest,. \ ' M e the fo rmer ,measured the r a t e

o f i n te res t in terms o f money, t h e l a t te r measured t h e r a t e o f i n te res t in terms

o f t h e command o v e r commodities, t h a t is , in terms o f t h e pu rchas ing power o f

money. Unless t h e general p r i ce leve l remained stable during t h e d u r a t i o n of

a loan, t h e t w o aforesaid rates a r e n o t identical.

Hypothet ical ly , Sarnat (1973) pract ical ised t h a t i f t h e r a t e o f I n te res t on a

one-year b o n d was say. 80 percent , but in f la t ion ra ised p r i ces by 6 percent ;

t h e rea l r a t e o f in terest in terms o f t h e purchas ing power was o n l y 2 percdnt .

What thi; Impl ied i s t ha t if a n investor gave up N100 a t t h e beginning o f t h e

yea r a n d rece lved HI08 a t year end, such money (N108) cou ld o n l y have purchase(

W102 w o r t h o f goods in re lat ion t o t h e beg in ing year 's p r i ces - Thus, i f the generi

level o f consumer pr ices increased, the rea l ra te o f r e t u r n on f i x e d - income

secur i t ies was less than t h e money r a t e a n d vice versa.

Thus, f rom t h e foregoing we see t h a t in f la t ion impairs t h e usefulness o f money anc

in some cases, des t roys money completely, pa r t i cu la r l y +f t he r a t e o f in f ta t ion i s

v e r y high. Hicks (in Hagger, (1977)) summed up t h e ef fects o f i n f l a t i on more

succ i r i t l y when h e said:-

" T h e hab i ts - business hab i ts as well as personal habi ts-

wh ich a r e based on t h e assumption o f stable p r i ces a r e too

s t r o n g t o b e easily broken. Nor i s it jus t habits, it I s also

ins t i tu t ions . The account ing system, t h e t a x system, even

t h e legal system, a l l a r e based on assumption o f a stable va lue

o f money.

If the value o f money i s ser iously changeable, these a r e tw is ted

. 46

to be t r u e profits; the taxes that a r e Imposed a r e

different t o what was intended; the fines and penalties

imposed by the courts a s well a s compensations which

they award, all lose their proper effect".

Kahn [I9791 in his opinion maintained that inflation does more than just t ransfer

wealth and income. He said, "It increases risks; it creates distortions; It decrease

the efficiency of the system; it erodes morale, integrity and discipline; and it

destroys faith and confidencet1.

CHAPTER THREE

RESEARCH METHODOLOGY

3.1 Preamble

One o f t h e main problems in optimal f inancial management o f th,e f i r m or. individ~

i s t h e selection o f investments from among many possib le a l ternat ives. Some

methods o f d iscr iminat ion ex i s t to select t h e 'best1 se t o f projects. Select ion of

assets w i thout r e g a r d t o r i s k i s done w i t h considerat ion o f t h e b e n e f i t s t o b e

ga ined f rom t h e assets where a forecast o r reco rd o f t h e cash in f lows d u e t o

t h e asset i s avai lable.

In t h e slmplest form, the wor th t o t h e f i r m o r indiv idual , o f a n asset i s t h e

sequence o f cash in f lows generated by t h e asset. T h e sum o f t h e c a s h in f lows

minus t h e cash payments can b e cal led t h e 'accounting n e t p r o f i t " (Jean,1970).

A l though t h i s f i g u r e cou ld b e used as a measure o f benefi ts, it i g n o r s t h e

time p a t t e r n o f cash inf lows a n d there fore the time va lue o f money.

.A l though the set o f cash inf lows cou ld b e considered as t h e aggrega te bene f i t

from t h e asset, it i s desirable t o summarise t h e l i s t i n g o f cash in f l ows i n t o a

s ing le number such as t h e Account ing Rate o f r e t u r n , the I n t e m a l Rate o f

Return , t he Net Present Value, etc; when two o r more projects a r e u n d e r

select ion considerat ion, It may, o n t h e o t h e r h a n d b e auspicious t o use Ratio

analyses t o evaluate pro jec t o r asset performance against t h e i n d u s t r y o r f i r m

average when cons ider ing the benef i t o f a pro jec t o v e r a t ime per iod .

T o measure a f irm's financial posi t ion a n d performance, two p r i m a r y measures

read i l y come t o m ind - Prof i tab i l i t y a n d Liquidity. ( C h r i s t y a n d Roden, 1973).

These terms answer the two al l - important quest ions of:-

i. How much is t h e business making fo r i t s owners ? and

ii. How able i s t h e business t o pay i t s b i l l s ?

A f i rms business performance can be measured by t h e use o f ratios. Ratios

i n v o l v i n g f i gu res from the income statement, t h e Balance Sheet, o r b o t h

reveal qu i te a lot about a company's financial pos i t ion to i t s management,

A ra t i o i s a q u o t i e n t o f two numbers. Often, a r a t i o b y i t se l f i s meeningless

un less i t I s i n t e r p r e t e d against s0m.e standard. T w o main ways e x i s t to ana lyze

a rat io. T h e f i r s t i s time series analys is w h i c h invo lves seeing how t h e r a t i o

has behaVed o v e r time. T h e second i s t h e c ross - sectional ana lys is in wh ich

t h e f i r m i s obse rved a t a s ingle po in t in t ime re la t i ve t o o t h e r f i rms or parameter

T o measure p ro f i t ab i l i t y . we think o f p ro f i t . T h e accountants a n d economists

de f ine p r o f i t d i f f e ren t l y . Fo r t h e accountant a n d businessman, p r o f i t i s synomync

w i t h owners ' earnings, f o u n d by subtracting a l l cos t f rom t h e to ta l r evenue

accru i t ig ' t o t h e f i r m during the opera t ing per iod.

T o t h e economist, p r o f i t I s a d i f f e ren t i a l r e tu rn , a special r e w a r d f o r r i s k -bead

o r f o r be ing c leve re r o r more e n t e r p r i s i n g t h a n one's competi tors. In t h e

economists1 p o i n t o f view, the account lng p r o f i t l umps together two v e r y d i f f e re r

so r t s o f re tu rns . F i r s t is t h e basic r e t u r n d u e t o t h e owners rnoney(equa1 t o

t h e o p p o r t u n i t y r a t e they cou ld e a r n b y i n v e s t i n g it in v i r t u a l l y r i sk less i n s t r u -

ments such as, T r e a s u r y B i l l s o r high g r a d e bond) a n d the second is t h e t r u e l

economic p r o f i t (a r e w a r d f o r r i s k - bear ing, o r a reward f o r s u p e r i o r a b i l i t y

t o take,manage a n d outguess t h e r i s k s ) . Thus, f rom the economists v iewpoint ,

a firm's r a t e o f p r o f i t can be rep resen ted as

K = ip+r . ......................... (3.1)

where K = r a t e o f p r o f i t

&pure o r r i sk less

r a t e o f r e t u r n t o capi ta l

r = r i s k premium for t h e pa r t i cu la r f i r m

We acknowledge t h e economists' d i s t r u c t i o n In p r i n c i p l e b u t for o u r pu rpose

h e r e we shal l t ake K in totality t o s tand f o r t h e accountant p r o f i t .

3.1.1 P ro f i t ab i l i t y Measures

Profitabil ity i s t o p r o f i t what ra te is t o an amount ( C h r i s t y a n d Roden, 1973) .

p r o f i t i s t h e f i g u r e a t t he bottom o f t h e income statement, r e p r e s e n t i n g

.-.--- .- .-. . .-. -..-. - -.--. --- -..-. =" - -- - - -- -- - - -. - - - . - - - - - - -

money amount; profitabiki-ty. i s a rat io. Because o f th is ,pro f i tab i l i t y i s a more

meaningful measure wh ich c a n be used as a s tandard of performance regard less of

a f irm's size. The normal amount o f a f i rm 's p ro f i t , in re la t ion t o another, i s

n o t v e r y meaningful in isolation. It however, makes more meaning if t h e sizes

o f assets genera t ing such pro f i ts a re re la ted t o each f irm's p r o f i t . This Is

where t h e p r o f i t a b i l i t y ra t i o becomes o f essence.

Many k i n d s o f p r o f i t a b i l i t y rat ios a re available:- Gross P r o f i t marg in ,C;ross

Opera t i ng margin, Net Opera t ing Marging, Sales margin, e a r n i n g power, R e t u r n

on Equ i t y etc.

3.1.2 Earninq Power

T h i s i s pe rhaps t h e bes t measure o f p r o f i t a b i l i t y ( C h r i s t y a n d Roden, 1973)

a n d one o f t h e most widely used measures o f p r o f i t a b i l i t y (Schultz Schultz, 1972:

T h i s i s t h e speci f ic r a t i o which most people have In mind whenever t h e y use t h e

te rm p ro f i t ab i l i t y . It i s calculated by d i v i d i n g tota l claims (assets) i n t o e a r n i n g

before i n te res ts a n d taxes,Schwltz a n d S c h u l t z (1972) r e f e r r e d t o i t as R e t u r n

on investment (ROI )

Earnings Power ( o r ROI) = EBIT ITo ta l Assets (Claims)

........ (3.2)

where

E B l T = Earn ings before In teres ts a n d Taxes.

The measure shows Management's ab i l i t y t o use t h e f irm's assets t o genera te

earn ings o n i t s i nves ted capital. The measure c a n show Investors, c r e d i t o r s anc

shareholders how ef fec t ive ly management i s u s i n g each u n i t o f money p r o v i d e d tr

generate earnings, a n d t h i s might o f ten in f luence investment decis ion o f these

groups.

3.2. Sources o f D a t a

3.2.1. 1 . In f l a t i on Rate

In th iswork , t h e al l- items consumer p r i c e index (CPI ) computed by t h e Federal

5 0

office o f s tat is t ics (FOSJ is ued as t h e choice index t o measure inf lat ion. T r

CPI i s chosen because o f i t s many advantages l i s ted ear l ier in t h e Review

o f l i terature, but more important ly because it measures var iat ions in t h e r e t i

. p r ices of those goods and services wh ich a t t reac t a substant ia l p rapor t i on of

t he aggregate expend i tu re o f wage earners. 3.2.2 2. ~ r o f i t a b i l i t y

In tills study we make "se'of E a r n i n g Power o r ~ e t u r n o n investment as

o u r p r o f i t a b i l i t y ra t i o .to compute t h e p ro f i t ab i l i t y o f t h e f i rms u n d e r investigatic

For each df t h e companies, the data require 'd fo r t he calculat ion ,of. RO I arc:-

a. F i xed Assets

b. C u r r e n t Assets

c , C u r r e n t L iabi l i t ies

d. Opera t i ng income.

These data a n d o thers a re obtained f rom the cornpanles' au thent ica ted Annual

Repor t and Staternent ,of Accounts. These a re detai led in Chapter fbcr ( f o r t h r

Balance Sheets). a n d the Appendix ( f o r t h e Pro f i t and ' b s s Account) .

S--nq Procedure a n d Sample Size

Four companies were dandomly selected u s i n g a simple random approach, T h e

cjolce o f more tham one company would make fo r a wider analysis. Companies

chosen were those wi th a fa i r l y long h i s t o r y o f existence o f n o t less than

15 years. T h e l i s t comprised b o t h quo ted and unquoted companies. T h e

d i spa r i t y in t h e na tu re o f business o f t he companies was a delib'erattzlj' chosen

factor designed t o ref lect the un ive rsa l i t y o r otherwise o f e f fec ts o f in f la t ion on

d iverse aspects - o f the economy.

T h e chosen companies inc luded :

(1 ) Diamond Breweries Ltd.

(2 ) Delta Glass Company Ltd.

(31 John Hol t Limited

( 4 ) Un ion Bank Nig. Plc.

3.4. I n r t ~ u m e n t s fo r Data Collect ion

Data f o r analys is were col lected from pub l i shed a n d authent ica ted documents

o f t h e sampled companies. In f la t ion data were as compiled by t h e Federal

Off ice of S ta t is t ics a n d pub l ished in var ious issues o f Cent ra l B a n k of

Niger ia (CBN) Annua l Repor t a n d Statement o f Accounts.

3.5 Techniques o f Data Analysis

O u r data a r e t o be analysed u s i n g t h e R e t u r n O n lnvestment techn ique in

which r e t u r n i s Operating Income (usua l ly P ro f i t Before i n t e r e s t a n d Taxes)

a n d Investment i s Total Assets (less in tang ib le assets). T h u s f o r a Company

X, t h e ROI wou ld be calculated us ing the formula.

ROI = OY I A T A - I A ....... (3.3)

Where OY = Operat ing income o r P B l T O r E B l T

A T A = Average Total Assets, and I A = In tang ib le A!jsets.

Two elements a r e thought t o b e Invo lved in the above formula namely,

Asset T u r n - O v e r and Operat ing Prof i t margin. In Jerome (1961) f o r instance,

ROI c a n also b e res ta ted as:

ROI = OPM x A T R ........ .(3.4)

where

OPM = Operat ing Pro f i t Marg in

ATR = Asset Tu rn -ove r Rat io

A T A = Average Total Assets

IFA = ln tang ib le F ixed Assets

NS = Net Sales

In t h i s work, we shall use equat ion 3.3 t o compute the p r o f i t a b i l i t y o f each

Investment (Company) under invest igat ion. For Comparison, t h e cross-

sectional po in t estimate o f t h e measure i s calculated wi th : i n f l a t i on a n d wi thout

i n f l a t i ona ry considerat ion.

For purposes o f calculating inf lat ion adjusted values o f total assets, the histor ic

costs (values) of the assets are multlpledby an appropiat@ Price-Index Relative

(PI RI , thereby obtaining. cu r ren t asset coste.

For instance, suppose that the value o f the assets o f a company a t end of years

X was W80 Million, and that the all-item CPI for end o f years X-1 and X

were 123.9 and 143.0 respectfvely, the inflation-adjusted value o f t he company's

assets a t the end o f year X would be g iven by:-

W80million x PIR [ f o r year X)

where

[PIR( for year X I = 143.0 - = 1.15 123.9

Thus, the inflation-adjusted value o f the company's assets a t end o f year

X would be:-

W80M X 1.15 = W92 Mill ion

Generally, the PIR i s the rat io o f two pr ice index values in which t he numerator

i s the price Index for the cur rent ( i n which the analysis was made), and

the denomina t0 r . i~ the pr ice index fo r the base year.

CHAPTER FOUR

PRESENTATION AND ANALYSIS OF DATA

4 .1 DATA PRESENTATION, ANALYSIS AND RESULTS

In this chapter, the data for analysis a re presented and analysed. For the

purpose o f presentation and analysis o f data, to make fo r ease in the exercise,

o u r case studies shal l be designated R, X, Y and Z to represent o u r Delta

Glass Company Limited, John Holt Limited, Diamond Breweries Limited and

Union Bank of Nigeria Pic respectively.

Start ing wi th R, the Balance Sheets for the years under consideration are

g iven overleaf.

Table 4.1 R COY - LTD. BALANCE SHEET, as a t 31st December, 1980

H is tor ic Cost Details

FIXED Assets [FA)

C u r r e n t Assets(CA1

s tocks

Debtors

Cash

~ e s s C u r r e n t L iabi l i t ies

Cred i to rs

Loans

~ a x a t i o h

D iv idends

Bank O v e r d r a f t

1 PIR I ln fa l t ion

Net C u r r . Assets o r . ( L iabi l i t ies)

Net Total Assets

jus ted Detai

PI , 'OOO

Calculat ing the Return on Investments fo r bo th cases; u s i n g h i s to r i c cost

detai ls (Ro t1 ) and us ing in f la t ion adjusted values [ R 0 I 2 ) based on Eqn

3.1 we have that.

R o l l ) = Operatinq Income - - Prof1 t Before In te res ts & Taxes

Net total Assets Net Tota l Assets

1 oo_ Percentage Drop I n ROI =(Roil1 .- R 0 1 2 - -9.12. 7-

ROl 1

Obviously, since the calculated value of ROI,) ROIZ, the actual return

on Investment is lower than what is obtained in the historic cost details.

A close look at Table 4.1 would show--- that the values of separate and total

assets without reckoning with inflation,are lower than the inflation -- adjusted

values of all the items.

Table 4.2 R COY Ltd. Balance Sheet, as a t 31st December. 1981

etails

q '000

81,902

- 10,305

92,207

Historic

FIXED ASSETS

CURRENT ASSETS

Stocks

Debtors

Cash

Less Curr. Liab.

Creditors

Loans

Taxation

Dividends

Bank Draft

Net C u r r . Assets

Net Total Assets

Inflation Adjusted Details Cost

P1 '000

13,096

19,147

1,108

33,351

6,936

4,555

2,061

5,443

4,051

23,046

Calculating

and

PI111,569,000

Percentage Drop = 17.42

We proceeded again t o look a t t he 1981 Balance Sheet o f t h e R Coy Ltd.

Ana lys is o f t h e Balarice Sheet data revealed p r o f i t a b i l i t y f igures .

Roll = 5.97% a n d

R 0 I 2 = 4 .93%

It i s t h u s apparent t ha t the R O I 1 > R O l 2 again d e r i v i n g f rom t h e fac t t h a t

our i n f l a t i on adjusted value o f Net Tota l Assets i s h ighe r t h a n t h e hi:storic

cos t va lue a t W 11 1,569,OOO a n d W 92,207,000 respect ively.

For Gmpany X , the Balance Sheet data a r e presented and analysed as per

Table 4 . 3 .

Table 4 . 3

X COY LTD. BALANCE SHEET , as at 31st December, 1982

FIXED ASSETS

Others

CURRENT ASSETS

CURRENT L IABIL IT IES

NET T O T A L ASSETS '

Historic Cost Details

PJ '000 ( PI '000 I

I r

P I R

1.08

1.08

flation Adjusted Details

Using the historic and inflation-adjusted data to compute project prof i tabi l i ty

w e ascertain that,

and

Percentage Drop = 7.45

It can b e seen t h a t ROI,)' R0I2, suggest ing t h a t t h e rea l r e t u r n o n Investment

of X Coy Ltd. i s lower u n d e r inf lat ionary condi t ions t h a n wi thout , r a t h e r

ind ica t ing t h a t informat ion der ivab le from the company data as presented i!;

misleading in t h i s respect. Ipso facto', o u r in f la t ion ad jus ted values o f company's

assets a r e h i g h e r than t h e unadjusted values represented in t h e h i s to r i c cost

accounts. T h i s has implicat ion fo r a p r o p e r unders tand ing o f t h e state of af fa l rs

o f t he company in re la t ion t o the y ie ld o f funds (assets)employed.

For the year 1983, the Balance Sheet of X ;:is presented on Table 4 . 4 a 5 follows:

Table 4.4

X COY Ltd. Balance 'Sheet as a t December 31st. 1983

F IXED ASSETS

0,thers .

CURRENT ASSETS

CURRENT L IABIL IT IES

From the relevant variables, we calculated our r e t u r n on assets as follows:

and

Percentage Drop - - 18.65

Again, we see R01>Ro12 reflected by a higher inflation adjusted value

of assets.

For company Y, f o r t he years 1984, 1985, 1986, 1987, 1988 a n d 1989 we

presen t a n d analyze Balance Sheet data f o r these years o n Tables 4.5;

4 .6 , 4.7, 4.8, 4.9 a n d 4.10 respectively.

Table 4 .5

Y COY LTD BALANCE SHEET AS A T 31ST DECEMBER 1984.

FIXED ASSETS

CURRENT ASSETS

Stock

Goods in t r a n s i t

Debtors

Loans a n d Advances

Cash

CURRENT L ~ A B ~ L I T I E S

Oderdraf t

Cred i to rs

D is t r i bu to rs ' C u r r e n t A1 C

Provis ion f o r Tax

Proposed D iv idend

Net C u r r e n t Assets l Lia.

Net Total Assets

Plus Pre-Operational Expenses

Tota l Assets

Historic C_r

P1 '000 ---- -

1,8Y7

203

448

2 2

3 ,517

6 ,037

746

4,214

2,141

1,926

1 ,600

10 ,627

Details

W 1000

18 ,578

( 4,5901

13,988

2,972

nformat ior

N '000

2 .586

284

627

3 1

* 8 ,452

1 ,044

5 ,900

2 ,997

2,696

2 ,240

14 ,877

4d jus ted Detai ls

PI '000

To calucate Rol l and ROl2 , we have tha t

and

'Percentage Drop = 28.56

Table 4.6

Y COY L T D BRLANCE SHEET AS AT-31 DECEMBER, 1985

FIXED ASSETS

CURRENT ASSETS

Stock

Goods in T r a n s i t

Debtor

Loans a n d Advance

Cash

Less C u r r e n t Liabi lRies

Overd ra f t .

C red i t & Accruals

D is t r i bu to r Cur r . A / C

Econ. Recov. Fund

Provis ion fo r Taxat ion II : fo r D iv idend

Net Cur ren t Assets

Add Pre-Operational Expenses

Total Assets

Historic Cost Details , . - . - - - . .-- -. P t i o n - A d j u s t e d Detail:

T o determine t h e p ro f i t ab i l i t y o f the company operations in the year In qgestion,

we calculate.

and R"12 = P1 5,256,260 = 0.3483 = 34.83%

P1 15,092,000

Percentage D r o p - - 0.99

With a relatively low inflation rate in 1985 we observed that the profitabil ity

of Company Y was marginally affected. Although ROI,) Rot2, we note that

the loss in profitabil ity due to inflation was only minimal. Raw assets values

show an increase o f PI 149,000 or about 1% with Inflation,than without i t .

Table 4.7 ----

Y Coy Ltd. Balance sheet as a t 3tst ,December. 1986

FIXED ASS,ETS

STOCK . Advances

Goods In .Transit

Ca sh'

Less Curr: Linbilitcs

Overdradt .

Creditors 5 Accrua4s

Distributors1 Curr AJc

Provision for Tax

Provision for Dividend

Net C u r r . Assets

Tota l Assets

To ascertain p r ~ f i t a b i l i t y for the year under consideration, we calculate our ,

ROI, and ROIZ values a s follows:

and

percentage Drop = 16.68.

We proceed to analize data for 1987 on Table 4 .8 .

Table 4 . B

Y Coy Ltd . Balance Sheet as a t 31st December, . I987

FIXED ASSETS

CURRENT ASSETS

CURRENT LlABI L lT lES

NET CURRENT ASSETS

NET T O T A L ASSETS

Historic Cost details l nflation Adjusted Detz

Calculating Return on Asset values o f Y Coy Ltd. in the year 1987, we have

that

and

Percentage Drop = 9.93.

For 1988 t h e Balance Sheet data a r e as shown o n Table 4.9.

Table 4.9

Y COY Ltd. Balance Sheet as a t 31st December, 1988

FIXED ASSETS

CURRENT ASSETS

CURRENT L IABIL IT IES

NET CURRENT ASSETS

NET T O T A L ASSETS

Hlstoric Cost Detai ls In f la t ion Ad jus ted Detai ls

T o calculate the Re tu rn on Assets for 1988 f o r Y Coy Ltd. We f i n d t h a t

and

Percentage Drop - -

A low level o f p r o f i t f o r 1988 also depic i ts a low r e t u r n o n assets based o n

h i s to r i c cost detai ls a n d much lower than r e t u r n under in f la t ionary tendencies,

We conclude ou r presentat ion and analysis o f Y Coy Ltd. performance by looking

a t t he i r Balance sheet f a r 1989 on table 4.10.

Table 4.10

Y Coy L td . Balance Sheet as a t 31st December, 1989

FIXED ASSETS

CURRENT ASSETS

CURRENT L IAB IL1T l ES

NET CURRENT ASSETS

NET TOTAL ASSETS

Histor ic Cost Detai ls Inf la t ion Ad jus ted Detai ls

PIR PJ '000

Profitability ra t ios u n e r t h e two situat ions a r e calculated as shown

a n d

Percentage D r o p = 33.23

Calculated ra t i o o f p ro f i t ab i l i t y reveal a low level o f p r o f i t u n d e r a n i n f l a t i ona ry

s i tua t ion pred ica ted by a high asset value. We wish t o observe t h a t f o r

company Y, as w i th companies R and X the re has been a pers is ten t d r o p in

p r o f i t a b i l i t y o v e r t h e years as Ro i l ) RO1 2 .

We would proceed to look a t Company Z unde r s im i l a r c i rcumstances. T h e

f indingCare represented on Tables 4.1 1,

Table 4.11

Z Coy Ltd. Balance Sheet as a t December 31 s t 1990

FIXED ASSETS

CURRENT ASSETS

Cash a n d Shor t T e r m fund

Bills Discounted

l nvestments

Loans a n d Advances

De fe r red Charges

C u r r e n t L iabi l i t ies

Loan Stock

Deposits . Others

Net C u r r e n t Assets

Histor ic Cc

PI '000

4,526

1,311

18

2,321

627

8,803

16

6.380

2.193

8 ,589

t Detai ls

W'OOO

' lation Adju:

W '000

ed - Detai ls

PI '000 - 469.907

To ascetain how i n f la t ion has af fected the p r o f i t a b i l i t y o f company Z f o r t h e

year, we now calculate o u r Re tu rn o n [Asset) Investment values u n d e r t h e

two d i f f e r e n t si tuat lons

Percentage Drop = 6.49

From Tables 4.1,4.2,4.3,4.4,4.5,4.6,4.7,4,8,4,9,4.10 ahd 4.11 amd nased o n

o u r calculations, t h e fo l lowing resu l ts were respect ively gotten.

F o r 19-84. ROl , = 39.79% For 1980, Ro l l = 2.41%

R 0 I 2 = 28.33% R 0 I 2 = 2.19%

F o r 1985, R o l l = 35.18% For 1981, .Roll = 5.97%

R 0 I 2 = 34.83% R O l i = 4.93% . .

F o r 1986, R o l l = 13.97% For 1982 R o l l = 12.62%

R 0 I 2 = 11.64% ROIZ = 11.68%

R o l l = 12009% F o r 1987, For 1983 Roll = 9.55%

R 0 I 2 = 10.89% R o t * = 7.77%

F o r 1988, R o l l = - 5.33%

.RO12 = 3.89%

F o r 1989,. Ro l l f 6.32%

R012 = 4.22%

Frorn each o f o u r respect ive p a i r o f kalculat ions f o r eadl year. 1980 to 1990,

i t can be seen tha t R o l l ) RO$, showing tha t t he r e a l r e t u r n s o n investments,

as revealed by the r e t u r n o n assets o f the f o u r companies were a l l lower when

we b r o u g h t in f la t ion data t o bear o n t h e companies' operat ions.

Also, when we, compared o u r In f la t ion ad jus ted values o f companies' assets w i t h

t h e unad jus ted values presented in t h e companies' Balance sheets, we not iced

an i n t e r e s t i n g revelat ion. See below.

F o r 1980,

I n f l a t i on ad jus ted value o f Net Tota l Assets ( I A V N T A ) , a n d (Unadj~lstc!d) Book

Value o f Net Tota l Assets ( B V N T A ) are g iven:

I A V N T A = ' W 57,682,000

BVNTA = N 52,437,000

For 1981,

IAVNTA = W llt,569,000

BVNTA = W 92,207,000

6 = PI 19,362,000

For 1982,

IAVNTA = W 250,178,000

BVNTA = W 231,646,000

For 1983,

For 1984

For 1985

For 1986,

For 1987,

For 1988,

For 1989,

IAVNTA = W 322,778,000

BVNTA = W 262,503,000

6 = N 60,275,000

IAVNTA = - W 23,744,000

BVNTA = W 16,960,000

6 = w 6,7~4,ooo

IAVNTA = W 15,092,000

BVNTA = W 14,943,000

5= t4 I 49,000

BVNTA = $4 15,382,000

d = W 3,076,000

IAVNTA = W 18,975,000

BVNTA = W 17,095,000

6= W 1,880,000

IAVNTA = W 25,802,000

BVNTA = W 18,834,000

d = PI 6,968,000

IAVNTA = W 35,832,000

BVNTA = W 23,888,000

6 = w ii,94~,000

For 1990 I A V N T A = W 470,135,000

BVNTA = W 439,479,060

6 = w 30,656,000

For each of t h e years, g i v e n the

ad jus ted va lue o f n e t tota l assets

(unadjusted) values.

above values, it is obvious t h a t t he i n f l a t i on

are, in a l l cases, h igher t h a n t h e h i s to r i c

4.2 TEST OF HYPOTHESFS

As s ta ted e 8 i e r In Chapter One, we have two hypotheses f o r t h i s s tudy , re-stated

as follows:

Hypothesis I : ln f la t ion negat ively affects t h e rea l r e t u r n o n Investment. Stated

in Nul l (Hkjl a n d A l te rnat ive [Ha) Forms, Hypothesis I becomes:-

Ho: l n f l a t i on does not negat ive ly a f f e c t t h e

Veal R e t u r n on Investment.

Ha : ln f l a t i on does negat ively a f fec t t he Re tu rn Investment.

Hypothesis I I : ln f l a t i on reduces the value o f Net tota l Assets.

Stated in Nu l l (Ho) a n d A l te rnat ive (Ha) forms, ~ ~ ~ & e s i s I 1 becomes:-

Ho : In f l a t i on does not reduce t h e value o f

Net Tota l Assets.

Ha : In f l a t i on reduces t h e va lue o f

Net Tota l Assets

In tes t ing Hypotheis I, t he decision ru les are:

If R 0 i 2 7, R o l l , accept Nu l l hypothesis.

On t h e o the r hand, i f R 0 2 4 ROl, accept a l te rnat ive hypothesis.

Where ROl a n d R 0 I 2 a r e as p rev ious l y def ined.

In tes t i ng Hypothesis II, t h e decision r u l e s are:-

If I A V N T A ~ B V N T A , - accept Nul l hypothesis.

On the o t h e r hand if I A V N T A 2 BVNTA accept a l te rnat ive hypothesis.

where I A V N T A a b d BVNTA are as p rev ious l y def ined.

S ta r t i ng w i t h Hypothesis, I beginning w i t h company R, for t h e year 1980,

R02 Roll (2.19) (2.41)

From t h i s resul t , t h e a l t e rna t i ve hypothe is i s accepted while t h e null hypothes is

i s rejected. Thus, in f la t ion negatively a f fec t s t h e r e t u r n o n i nves tmen ts .

7 3

For the year' 1981,

R 0 I 2 Roll

(4.93) (5.97)

Based or1 the above, ttic alternative t ~ y r ~ o ~ l ~ c s l s is accoptcd whlle t l ~ nul l

hyphothesis Is set aside.

. . With respect to company X, for the year 1982.

and for 1983

O n the s t reng th o f the above information, the Nul l hypothesis i s re jected and

the alternative Iiypothcsis is acccptcd for boll1 years.

For company Y , for the year 1984

(28.39) ('39.74)

Fbr 1985 RO12 L R o l l

(34.831 (35.18)

For 1986

For 19117

ROIZ L R o l l

t10.89) (12.091

For 1988

R 0 I 2 Roll

( 3 . 8 9 ) (5.33)

a n d f o r 1989

ROl

For a l l t h e years under consideration, we observe t h a t R 0 I 2 was pe rs i s ten t l y

less than R o l l and we thus set aside t h e Nu l l hypothesis and accept t he

a l te rnat ive hypothesis.

For Company z In 1990,

R012 L R o l l

Suggesting, once again tha t we reject t h e Null hypothesis a n d accept t he

a l te rnat ive hypothesis. General ly therefore, it can b e easi ly obse rved t h a t

resu l ts o v e r t h e years; f rom a l l the f i rms Investigated, conclusively p r o v e o u r

Hypothesis lasear l ier s tated t h a t in f la t ion negat ive ly af fected t h e R e t u r n o n

Investment.

In tes t i ng Hypothesis II, we beg in w i th Company R,

For t he ..<year 1980,

I A V N T A > BVNTA

a n d fo r 1981

I A V N T A BVNTA

(W111.569rn) (W92,207m)

From t h e above informat ion we re ject t h e Nu l l hyphothes is a n d accept t h e

A l te rna t i ve hypothesis; which i s tha t i n f l a t i on reduces the value of t h e firm;

Net Tota l Assets.

Fo r Company X for t he year 1982

I A V N T A ) BVNTA

(N250. 178m) ( W 231,646m)

a n d for 1983

I A V N T A 77 BVNTA

Thus fo r Company X we reject the Null hypothesis and accept the al ternat ive

hypothesis.

To study the state o f Hypothesis II for Company Y we look a t t he , va t - l ox Asset

values f o r the years under consideration

For 1984,

IAVNTA 7 BVNTA

(W23.74) (W16.960m)

br 1985

IAVNTA > BVNTA

(N15.092m] (fJ14.9431

For 1986

IAVNTA > BVNTA

For 1987

IAVNTA > BVNTA

iW18.975rn) (fJl7.D95ml

For 2988

IAVNTA 7 BVNTA

(N25.802m) (W18.834m)

and fo r 1989

IAVNTA 7 BVNTA

(N35..832m) (W18.834)

Available information fo r company Y above recommend that we reject Null

Hypothesis 11 and accept the Alternative Hypothesis. l I .

For company Z in 1990,

IAVNTA > BVNTA

(W470.135m) (W2$39,479m)

We also set aside the Nul l Hypothesis while we accept the alternative hyphotesis

accordingly.

On the whole, therefore, it i s evident t h a t t h e resu l ts over t h e yea rs ( f o r

the companies emp i t i ca l l y ana1ysed)conclusively p rove ou r Hypothesis 1 I. One

can then 6ay wi thout hesitat ion that i n f la t ion reduces . the rea l value o f Assets.

For each p a i r of results, it may' b e a rgued t h a t t he degree o f reduc t i on i s

minimal. T h a t n o t withstanding, t he ove r - r i d ing conclusion t h a t i s deducib le

from the resu l t s o f the analysis i s t h a t i n f l a t i on - reduces the value o f the

f irms' assets.

CHAPTER FIVE

SUMMARY OF FINDINGS, CONCLUSIONS AND RECOMMENDATIONS

5.1 Summary of Findings

Thd f indings emanating from this s tudy ban be sumrniiriskd as follows, along the

l ine o f the Hypotheses, for ampany R.

a. Inf lat ion negatively affected i t s r e t u r n on investment, thus i t s p ro l i tab i l i t y

and

(b) lnf lat ion reduced the r6al valoe's o f - i ts : assets,,

For Company X I

(a) lnf lat ion negatively affected i t s r e t u r n on investment and thus i t s prof i tabi l l t )

(bl InflationredLl'ced tf-ersalvalue o f i t s assets

For Company Y,

(a) lnf lat ion negatively affected i t s raturn on investment o r p ro f i tab i l i t y

(b) lnf lat ion reduced the value o f i t s assets.

. !

FOP Company 2,

(a) lnf lat ion negatively affected i t s prof i tab i l i ty o r Return o n Investments and

(b ) lnf lat ion reduced the value o f i ts assets.

Having satisf ied the hypotheses, other f indings derivable from the s tudy include

i . Failure to incomporate lnf lat ion considerations in &terming investment

prof i tab i l i ty would of ten lead to an over-stating o f a firm's networ th

ii. That fn valuation o f a project o r in Budgeting fo r Capital expendi ture,

consideration o f Inf lat ion was more l ike ly t o reveal a more real ist ic project

EValuation and Capital Budgeting f o r a part icular investment.

iii. ln f la t ion reduces the earning power and effective prof i tab i l i ty o f investments.

5.2 CONCLUSIONS

Although a tedious work, th is project has been nonetheless interest ing. We

would want to conclude from the results o f th is work that in al l cases.

1 . lnf lat ion reduces the values o f component assets o f a company's f inal account

in degrees relat ive to both the asset histor ic cost :and to the inf lat ion ra te

prevail ing. 7 8

2 . Although nominal p ro f i ts o f lnvestments seem tobeincreasing and improving,

inf lat lon factors, .when taken in to considerat ion reveal the opposite,

3. Relative p ro f i t s ove r time can on ly b e comparable i f in f la t ion considerations

a r e b rough t t o ptdy.

5.3 RECOMMENDATION

The following recommendations are imminent from the study.

1. Companies should incorporate the inf lat ion element when looking a t t h e i r r e t u r n

Th is represents one o f the logical ways o f real ist ical ly apprais ing r e t u r n s insteat

o f re l y ing on book values which o u r s t u d y revealed, a re mostly mislaading.

Th is approach wi l l encourage management b f organisations to devise rnore

strategic ways o f Increasing project yields.

2. In p lann ing expenditures of a Capital nature, inf lat ion parameters must

necessarily b e used in such cases so as t o ensure the v iab i l i t y o f such plans.

* 3 . Firms and agencies involved i n evaluation 6 f projects must consider in f la t ion

as a c r i t i ca l factor i f such projectsaret0:have a chance o f surv ival .

5.4 AREAS OF FURTHER l NVESTICATION

Th is work investigated the general effects o f inf lat lon, us ing the all-item (carnposltc

consumer pr ice Index. A more specific s tudy o f inf lat ion and i t s ef fects -can b e

re lated t o specif ic consumer items.

From the above, comparative efects of in f lat ion on various identical Investments can

be revealed. From tha t point o f view, it could b e deduced which investment

planners, more effectively hedged against inf lat ion than the others.

A t r e n d analysis o f in f lat ion effects on any one investment would be useful .it would

reveal a pa t te rn tha t could be used to pred ic t f o r inf lat lon in f u t u r e pro jec t

evaluations.

Ahmed, A, (1986). Federal Government o f Nigeria Budget fo r 1986:

Problems and Prospects.

CBN Economic and Financial Review '

Ajayi, S.I. and Ojo, 0.0. [1981). The theory o f Inflation. In money _*L_

and Banking, Analysis and Policy in the Nigerian --. &

Context. Allen and Unwin Ltd Publishers. Londorr P.P 325

Bierman, H. and Smidt, S. (1980). Capital Budgeting and Inflation. I n

Capital Budgeting Decislon. Macimillan Publishing Company &

Inc. New York. Lwndon PP325

Bones~;, A.J. (1972). .Investment Cr i ter ia and Procedures in the pr ivate Sector.

In Capital Budgeting. - , Longman. PP 22 - 72

Brown,A.J. and Darby, J. (1985). ce 1950: An International

Comparative Study, Cambridge University Press, L.ondon.

Brown, A. J. (1985) . Consumer Prices and Prices o f Traded Goods. In World

Inf lat ion Since 1950. Cambridge Universi ty Press

London. New York,Sydney PP 6-7

Brown, E.H. and Hopkins, S.V. (1956). Seven Centuries o f the Pr ice of

Consurnables Compared wi th Builders' Wage Rate

Browne, H. and Coxon, T. (1981). Inf lat ion - Proofing your Investments. w - - -

William Morrow and Company Inc. PP 2 5 - 4 4 .

Burns, A (19711. The combination o f r is ing prices and h igh Unemployment I n

our Country. Federal Reserve Bullet in August 1971 P. 656 -----------

Ball, R.J. (1973). The General Price level. In Inflat.ion. and the Theory *- of

-.Allen and Unlwin Ltd PP 13 - 17

Bussey, L.E. (1 978). The deterministic Investment Analysis. In Economic - A n a l p s o f Indust r ia l Projects. Pren'tice Hall Inc. New'

Jersey P.200

Business Times Vol. 1 1 (18) I l986), Vice - Chairman's

Statement a t the Annual General Meeting o f IBWA-Afr ibank on R ~ : p o r t s

and Accounts f o r the year- ended December 31, 1985.

Cagan, P. (1956). The monetary dynamics o f hyper- inf lat ion. In Studies

in the Quanti ty theory of money. Friedman, M.IEd1

Chicago Univers i ty Press.

Centra l Bank o f Nigeria Annual Report a n d Statement o f accounts f a r t h e

Years Ended 31 December 1980 - 1990.

Chaines, A; Cooper, W.W. and MlIler, M.H. (.I9591 Applicalton of l inear

F'rog;amrning t o Financial Budget ing and the Costing o f : Funds

Journal o f Business 32 (1) : 20 - 46

Christy, G.A. a n d Roden, P.F. (eds) (1973). Pro f i tab i l i t y and Tu rn -ove r

In Fmance, Environment and Decisions. Canfield Press San Francisco.

Chu, K . and Feltenstein, A. (1979). Ext ra-ord inary Inf lat ion: The Argent ine

Experience

Finance and Development - 16(2) : -- 32 35

Duesenberry, J. (1 977). Inf lat ion and Income Distr ibut ion. In Inf lat ion Theory - - - - and Ant i - inf lat ion Policy P.265

P

Fama, E.F. and Schwert, G.W. (1977). Asset Returns and Inf lat ion.

Journal of Financial Economics, S(2) : 113 - 146

The Purchasing Power o f money Macmillan Press. New York

Florence, P.S. (1975). Stagflationiin Great Br i ta in : The ole o f L a b o u r ( l n The

Roqt o f Inf lat ion. Blair, J .M. (Ed). B u r t Franklhi..:. a n d Company Inc. P.69

Freedrnan,M. (1956) Studies i n the Quant i ty , Theory o f Money. Chlcago

Univers i ty Press.

Freeman, M. (1 973). Money and Economic Development, Praeger. New York

Goodman, L.J. a n d Love, R.N. (1979). Management o f Development Projects: - An Internat ional Case Study Approach Pergamon Press New Y o r k P.5

Cr i f f i t h , B. (1976). Def in ing Inflation. In, Inf lat ion: The p r i ce o f p rosper i ty . -

apl2-13,Holmes a n d Maer Publisher Inc. New Y o r k

Hagger, A . I . (1977). Inf lat ion: Theory a n d Policy.

The Macmillan Press Llmi ted London.

'

Hanson, J.C. (1978). The valire o f money In, .Text book o f Economics.

..McDonaldc a n d Evans Limited. P ~ Y 393 - 394.

Harberger, A.C. ( 1972). Techniques o f Project Appraisal, In, Project Evaluation. -

Clark Publishers Limited pp 1-21.

Heichelheim, F.M. 119681. An Ancient Economics H i to ry Vol 1. A.W.

S ig thof f Leyden PP 542

Hicks, J.R. (19391 Value a n d Capital . O x f o r d Un ivers i ty Press PP 159 - 160.

Holsen, J .A. (1 975). World Bank Techniques for Count ry Evaluation. In,

Financing a n d Risk in Developing Countries. Goodman, S. (Ed).

Praeger Publ ishers Limited New Y o r k Q90.

Jean, W.H. (1970). Measuring Benefits from an Investment. In The analyt ical

Theorv o f Finance: A s tudv o f the Investment .Decision

Process. o f -the Indiv idual and the Firm.

Holt Rinehart and Winston inc. New York, Chicago pp. 206.

Jerome, W. T. ( 1 961) . Return on Operative Investment. The Dupont Approach.

In, Executive Control - The Catalyst. John Wiley and Sons

Inc. New. York.

Johnson, H. G (1972) Fur ther Essays in monetary ~Econornics. Al len and

Unwin Ltd. London p p 325.

Kahn, A.S. (1948) The Warehouse Problem.

Bullet in o f American Mathematical Society

Kahn, H (1979) Inf lat ion and In f la t ion COrrectlOn

In, World Economic development,

1979 and Beyond. Croom Helm Ltd.

London p p 294 -328.

Klein, B . { 1977) The Social costs o f the Recent Inf lat ion: The mirage o f

steady Anticipated Inflat ion. In, Inst i tut ional Arrangement

and the lnf lat ion problem. A Carnegie Rochester

Conference Series on Public Policy. Brumer, K and Meltzer,

A.H. (Eds) Nor th Holland Publishing New York Oxford.

Lerner, A.P. (1949) The Inflat ionary Process. In Review o f Econornlcs and Statistics. pp 193 - 195.

Letiche, J .M. (1 969) The key Problems o f Economic Reconstruction and

Development In Nigeria. A n Address del ivered

Under the auspices o f the Nigerian Ins t i tu te f o r

International Affairs Lagos. Nigerian National Press

Apapa.

Levinson, C. (1971) Capital Inf lat ion and the multinational. Al len and Unwin

Ltd. London p I f and 18.

Levy .H. a n d Sarnat, M (1978). ln f lat ion a n d f inancial Decision making.

1 n, Capi ta l Investment and Financial Decisions

Prent ice Hal l Internat ional Inc, London

Inc. London p 314 - 323,

Lor ie, J. a n d Savage, L.J. (1955) Three problems In capital Rationing.

Journal o f Business, 26[4) : 229-239.

Maulding, R. (1972)

Means, G.C, (19751

Neumark, F. (1977)

Nwankwo, G.0,(1980).

Olashore, 0 (1987)

Paish F.W. (1969

Phill ips, A.W. (1958)

The Maulding Memorandum On incomes.

Times 16. 12 Sept. 1972.

Simultaneous I nf la t ion and Unemploy msnt

A chal lenge t o Theory and Policy. In, The

Roots o f Inf lat ion. p 2 - 3.

A model o f Capi ta l ! Budget ing U n d e r F:isk. In,

Studies in Budget ing. Byrne, R.F. Chaines, A

Cooper, W; Davis, 0. a n d Gi l ford, D, (Eds).

Nor th Hol land Publ ishing Company, Amsterdam.

London pp 48 - 70.

Effects qf l n f l a t i on o n Publ ic Revenue a n d

Expendi ture. In ln f la t ion theo ry a n d Ant i -

ln f la t ion pol icy. Lumberg, E. (Ed) Mac Mil lan

Press Ltd. London p p 338 - 349.

Funct ions o f t he Centra l Bank o f Niger ia.

The Trad i t iona l Functions, In N ige r ian - Financial System. MacMillan Press Ltd, pp 22-23

The Impact o f SFEM on Account ing Methods.

Business Times Vol, 12 No. 15 o f 13 P.prll,

1987. p 9.

Rise a n d fa l l o f Incomes Policy. I n s t i t u t e

o f Economic Af fa i rs. p. 20.

The Relat ion between Unemployment a r d the

Rate o f change o f money wage ra tes i n the U.K

1861 - 1957 Economics Vol. 27 283 - 299.

Pigou, A.C. (19171 T h e Value o f money

Quar te r l y Journal o f Economics, 32.

Randle, J. K. (1 987) . The Effect o f SFEM on Account ing Methods

a n d Proceedings. Business Times Vol. 12 No. 25 o f 22

June 1987.

Ricardo, D . [ 1951 3 , Principles o f Pollcical Economy a n d Taxation. Vol 1

Piero Sral f i led (Ed] Cambridge U n i v e r s i t y Press. p. 298.

Robbins, L. (1 972). Inf lat ion, A n In ternat iona l Problem In, In f l a t i on

as a Global problem. Randall H. (Ed.) Hopkins U n i v e r s i t y

Press. Baltimore. London. pp 10-25

Rockley, L.E. (1981) . Account ing fo r Inf lat ion. In, Finance f o r t h e

Non Accountant. Business Book Ltd. London. pp 125-127

Rostow, W.W. (197B). T h e World Economy: H is to ry and Prospects.

U n i v e r s i t y o f Texas Press Aust in. London pp833.

Rotwein. E.(1955) of Money, In, Wri t ings On Economics.

Nelson. p p 37 - 38

Rutledge, J . [ 19741 A monetarist model o f l nfa l t lonary Expectations. Lex ington

Books p.1.

Sarnat, M. [1973) . Purchasing Power Risk, Portfolio Analysis and t h e

case f o r Index l inked Bonds. Journal o f Money, c red i t a n d

Banking.

Schultz, R.G. a n d Schultz, R.E. (T9711 Basic Financial Manaqement: T e x t , - problems and cases.pp 58-59. l n t e x t Educational publ ishers.

Turvey, R. ( 1951 ) . Theory o f In f la t ion In a closed Economy. -- Eco~ern i c

Journa l , 531 - 535.

Tuttle, F.W. and Perry, J.M. (1970). A n Economic h i s t o r y o f t he U n i t e d

States. South Western Pub l ish ing Company Chicago. New York .

Cal i fornia. pp 826.

Vaish, M.C. (1982) Inf lat ion. In. Money Bank ing and Internat ional T rade

4 t h Edn Vikes Publishing House PVT Ltd. pp 176-206

Vickey, B.G. (1973. Pr inc ip les and Practise o f Book-Keeping and

Accounts,Mendes, B. (Ed) . Donnington Press .p. 86

Weingartner, H .M. (1965) . Equipment Repalcement Analysis : A note

o n t h e Optimum lnvestment Period. I ndus t r i a l Management,

Review, 7 ( l ) : 47 - 51. --

Welngartner, H.M. [1966) . Cr i te r ia f a r Programming lnvestment Projec:t

Selectionr Journal o f I ndus t r i a l Economics, 1 5(1): 65 - 76. - Weston, F.A. a n d Brigham, E. (1980) Capital Budget ing Techniques.

In, Manaclerial Finance.

Willoughby, C, ( 1 977). EX-Post Project Evaluation. The Bank's

Experience. Finance a n d Development, l 4 ( 1) : 29 - 31

APPENDIX

APP.1 ALL-ITEM CONSUMER PRICE INDEX (CPI)

1. Sources: 1980-82 CBN Econ. a n d Fin. Rev. 20(2 ) Dec. 1982

1983-85 CBN Econ. and Fin. Rev. 23(4) Dec. 1985

1986-90 CBN ~ ' n n . ~ e p . & Stat o f Acts. Dec. 1990

Base Year. (1980-85: 1975 = 100 1988 - 1990: 1985 = 100)

2. PIR: For f98x = CPI For 198x

CPI For 198x-1

Pr ice Index Relat ive (PI R ) 2

1.10

1.21

1 .O8

1.23

1.40

1.01

1.20

1 .ll

1.37

1 .50

1.07

Year i 1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

C P I ~

204.8

247.6

266.5

328.5

458.4

483.7

119.7

132.6

182.2

273.3

293.4

APP. 1

APP. 3

R Coy Ltd. Prof i t and Loss Account 1980 - '81

l tern

Turn Over

Taxat ion I 748,845 I 1,296,085

Pro f i t Before Taxat ion

P ro f i t A f t e r Taxat ion 517,111

1980 (Pl ) I 1981 (N)

1 ,265,956 '5,502,358

X Coy Ltd Prof i t and Loss Account 1982 - '83

30,441,456

l tern I 1982 (N ) 1 1983 (N)

- 41,017,654

Turn Over

P ro f it Before Taxat ion

Taxat ion

P ro f i t A f t e r Taxat ion

Y Coy L t d Pro f i t and Loss Account 1984 - '85

l tern 1 1984 [N ) I 1985 ( P I ) I --

T u r n Over 1 27,431,490

Cost o f Sales 1 - 15,263,946 Cross P ro f i t

Add. O the r lm

Less Sel l ing and

A d m i n Expenses

Net P ro f i t

12,167,544

- 313,717

12,481,261

5,740,517

6,740,544

APP.4 Y Cay Ltd P r o f i t a n d Loss Account 1986 - '87

1987 (W)

T u r n Over 23,668,640 16,852,562

Less Cost o f Sale 11,797,943-

Gross P ro f i t 7,061,222 5,054,619

Add. Other Income

Less

Sel l ing a n d Admin . Expenses

Loss Before Taxat ion

APP.5 Y Coy L t d p r o f i t a n d Loss Account 1988 - '89

l tern

Turn Over

P ro f i t Before Taxation

Taxat ion

P r o f i t A f t e r Taxat ion

APP.6 Z Coy Ltd Pro f i t and Loss Account 1990

l tern I 1990 ( W '000)

Gross earn ing

Less Cost o f Earning ( I n te res t Paid)

Less

Other Expenses

P r o f i t Before Taxation

- 1989 (PI)

32,8Ol,Jl8

1 ,SlO,5l7

690,894

819,623