Valuation, 7th Edition

21 Nonoperating Items, Provisions, and Reserves

To project free cash flow, you would typically focus on operating expenses, such as cost of sales, distribution expenses, selling expenses, and administrative expenses. But what about nonoperating expenses, such as business realignment expenses, goodwill impairment, and extraordinary items?

Nonoperating expenses are infrequent or unusual charges that are indirectly related to the company’s typical activities and not expected to recur. The conventional wisdom is that discounted-cash-flow (DCF) calculations should ignore nonoperating expenses as backward-looking, one-time costs. Yet research shows that the type and accounting treatment of nonoperating expenses can affect future cash flow and in certain situations must be incorporated into your valuation.

This chapter analyzes the most common nonoperating expenses. These include the amortization of acquired intangibles, restructuring charges, unusual charges such as litigation expenses, asset write-offs, and goodwill impairments. Since noncash expenses will be accompanied by a corresponding provision, we create a classification system of various provisions and describe the process for reorganizing the income statement and balance sheet to reflect the true effect of such provisions, if any, on company value. We show how to treat provisions in free cash flow and equity valuation.

Nonoperating Expenses and One-Time Charges

Given their infrequent nature, nonoperating expenses and ...