Damodaran on Valuation

3.6. CONCLUSION

When valuing a firm, the cash flows that are discounted should be after taxes and reinvestment needs but before debt payments. When valuing equity, the cash flows should be after debt payments. In this chapter, we considered some of the challenges in coming up with these numbers for firms.

We began the chapter by looking at the limitations of accounting measures of earnings and how best to adjust these earnings for miscategorized items such as operating leases and R&D. To state this operating income in after-tax terms, we need a tax rate. Firms generally state their effective tax rates in their financial statements, but these effective tax rates can be different from marginal tax rates. Whereas the effective tax rate can be used to arrive at the after-tax operating income in the current period, the tax rate used should converge on the marginal tax rate in future periods. For firms that are losing money and not paying taxes, the net operating losses that they are accumulating will protect some of their future income from taxation.

The reinvestment that firms make in their own operations is then considered in two parts. The first part is the net capital expenditure of the firm, which is the difference between capital expenditures (a cash outflow) and depreciation (effectively a cash inflow). In this net capital expenditure, we include the capitalized operating expenses (such as R&D) and acquisitions. The second part relates to investments in noncash working capital, ...