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Accounting Choices Impact on Enterprise Valuation

Explore how accounting methods affect RNEA and REI using GAAP and non-GAAP. Analyze valuation differences and forecasting challenges. Learn about the impact of depreciation methods on profitability and firm valuation. Understand the importance of steady state in accounting choices.

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Accounting Choices Impact on Enterprise Valuation

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  1. Homework exercise: presentation Matt Ramirez

  2. Part 1: R&D forecasting

  3. Part a: expected enterprise income, rnea, rei using gaap accounting

  4. Part b: expected income, rnea, rei using capitalization (non-gaap)

  5. Part c: why is rnea & rei different under the 2 methods? • Although accounting choices should not affect value in the long run, in the short-term these values such as RNEA and REI are different • The expensing vs. capitalization of the expenses drastically alters NEA and EPAT, therefore affecting RNEA and REI • No steady-state

  6. Part d: forecast of rnea & rei for 2020 using gaap

  7. Part d: forecast of rnea & rei for 2020 using non-gaap

  8. Part d: why are both forecasts different? • They are different because there is still no “end” or “continuing value” meanings that the accounting choices still have an effect • The choice to expense rather than capitalize still has an effect and shows a change one year later • The changes have not “caught up” (e.g. a perfect steady state has yet to be reached) therefore the same differences continue

  9. Part e: valuation of firm using gaap

  10. Part e: valuation of firm using non-gaap

  11. Part e: why are valuations different? • No steady-state has been reached: the non-GAAP valuation is just beginning to see positive REI • The GAAP method captures the positive REI within the current horizon, leading to a much higher value • The non-GAAP method shows a negative value due to negative REI due to much higher NEA values from capitalization (rather than expense) of R&D

  12. Part f: difficulties valuing firm by forecasting only to 2016 • The window of time is much shorter: accounting changes still have yet to “catch up” • While the horizon is more clear, the future forecasts are still unknown and should still be included • A steady-state will not have been reached yet in 2016: differences in value will occur because the accounting still has an effect through 2016

  13. Part g: rnea with decreasing expenditures

  14. Part g: explanation of why rnea is higher • RNEA is higher because Enterprise Income is higher due to less R&D expense • Although sales are growing at a lower rate, due to less R&D expenditures, there is now less expense to record against sales • Average NEA remains the same as the first example

  15. Part 2: depreciation, profitability, valuation

  16. Part a: epat & nea forecast using 3 year depreciation

  17. Part a: epat & nea forecast using 5 year depreciation

  18. Part b: which forecasts show firm to be more profitable in 2017? • The 3-year depreciation forecast is more profitable by $100 million • The lower-depreciation forecast is more profitable because its current-year depreciation expense is lower: it only has depreciation expense from past 3 years, rather than the past 5 • Lower depreciation expense against revenues makes it look more profitable in 2017 compared to the 5-year depreciation method

  19. Part c: valuation of firm using 3 year depreciation

  20. Part c: valuation of firm using 5 year depreciation

  21. Part c: valuation of firm using 3 year depreciation

  22. Part c: valuation of firm using 5 year depreciation

  23. Part c: explanation • Both values are the same: the accounting choices will not alter intrinsic value over time • Once steady-state has been reached, value is the same, as different accounting choices will correct themselves over time

  24. Part d: reply to company founders • While the market may add higher value with higher earnings, overall, it will not make a difference • Eventually, both methods will reach a steady state, and the market will adjust to its value accordingly • As long as a method is acceptable, then the method chosen should be the one that best suits the company and what they are comfortable with: preference on capturing value within horizon/beyond the horizon, earnings in current period, etc. • Accounting choices do not matter in the long run

  25. Part e: reasons for using different depreciation methods • Certain depreciation methods might make some periods look better than others • Using a longer depreciation period could be beneficial to “boost” earnings in a later period, or a shorter to do the opposite • Depreciation can also affect NEA and therefore RNEA, providing other incentives to alter projections for certain future periods

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