1 / 18

Homework Exercise

Homework Exercise . Kevin Pribil. Agenda. R&D Brief introduction Answers to A-G Depreciation Brief Introduction Answers to A-E. R&D. Managers are incentivized to capitalize R&D investments that should be expensed under GAAP

licia
Download Presentation

Homework Exercise

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. Homework Exercise Kevin Pribil

  2. Agenda • R&D • Brief introduction • Answers to A-G • Depreciation • Brief Introduction • Answers to A-E

  3. R&D • Managers are incentivized to capitalize R&D investments that should be expensed under GAAP • How does this effect the enterprise valuation under the Residual Enterprise Income Model? • …

  4. Requirement A • Calculate expected enterprise Income • Calculate return on net enterprise assets (RNEA) • = EPAT/ avg(NEA)

  5. Requirement A (cont.) • Calculate residual enterprise income

  6. Requirement B • Calculate RNEA • Calculate residual enterprise income

  7. Requirement C • RNEA and residual enterprise income are both higher when management chooses to expense R&D against income • They are different because when management capitalizes and amortizes R&D, expenses decrease. • Only amortization effects income, not R&D

  8. Requirement D • Forecasts for 2020 are different because amortization is different than the expense they expect to incur.

  9. Requirement E • The valuations differ • Under GAAP accounting, enterprise value is- • $454 • Under non-compliant GAAP account, it is- • $359

  10. Requirement F • If forecasted only until 2016, the amortization would not have become stable yet • This would have skewed the enterprise valuation

  11. Requirement G • RNEA is higher because R&D expenditures generate $1.60 worth of revenue per dollar spent • Other expenses do not generate as much revenue

  12. Depreciation • A firm is evaluating a decision to begin manufacturing a new communications device in 2013 • The firm is planning an IPO in 2018 and wants to ensure books look attractive to investors in 2018 • How should the CFO estimate useful lives of the investment needed for this project? • Must also consider attractiveness at time of IPO

  13. Requirement A • Forecasts assuming 3-Year depreciation

  14. Requirement A (cont.) • Forecasts assuming 5-Year depreciation

  15. Requirement B • 5-Year depreciation schedules show Net Income to be higher in 2017 • In the 5-year schedule, less depreciation expense has been deducted from net income because over 5-year depreciation, the annual expense is less

  16. Requirement C 3-Year 5-Year

  17. Requirement D • The founders insist the value will be higher because the reported income value will change and be more/less attractive to investors • However, depreciation is a non-cash expense and essentially does not affect the value of the company because, regardless, the depreciation will be accounted for

  18. Requirement E • Using shorter-term depreciation may aesthetically have an increase in IPO share-price. • Typically, IPO’s have minimal returns after the opening day. • I believe that, regardless, the IPO price won’t be correlated with a share price in 2022. • Based on managements beliefs, 3-year depreciation will have a higher expense in the short-term leading to potentially higher share price in 2022.

More Related