Abstract A model for estimating the change in the economic value of a firm due to the adoption and use of last in, first out (LIFO) under conditions of certainty has been presented. The model requires single-point estimates of three parameters: the marginal tax rate, the cost of the basic inventory and the ratio of the cost of capital of the firm to the anticipated rate of inflation. In estimating the effect of LIFO on the economic value of the firm, the analysis has been limited to the net present value of future cash flows. Any additional risk that the firm may have to bear due to uncertainty in the future rates of inflation and, therefore, in the effect of LIFO on the firm has not been considered. Indeed, there is some empirical evidence available to indicate that the adoption of LIFO is accompanied not only by an increase in the market value of the firm, but also by an increase in the market risk of its ownership shares. The critical assumptions of the model are that the physical quantity of inventory remains constant and the rates of price change, discount and taxation are known deterministically.
Shyam Sunder (Thu,) studied this question.