Consider a firm for which the nominal required rate of return is 8 percent. The rate of inflation is 3 percent. Compute the P/E ratio of the firm under the following situations:
i. The firm has a full inflation flow-through.
ii. The firm can pass only 40 percent of inflation through its earnings.
iii. The firm cannot pass any inflation through its earnings.
What pattern do you observe from your answers to items (i) through (iii)?