invretA - Aswath Damodaran 194 Back to First Principles...

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Unformatted text preview: Aswath Damodaran 194 Back to First Principles Aswath Damodaran 195 Measuring Investment Returns I: The Mechanics of Investment Analysis l Show me the money z from Jerry Maguire Aswath Damodaran 196 First Principles Aswath Damodaran 197 Measures of return: earnings versus cash Fows Principles Governing Accounting Earnings Measurement Accrual Accounting : Show revenues when products and services are sold or provided, not when they are paid for. Show expenses associated with these revenues rather than cash expenses. Operating versus Capital Expenditures : Only expenses associated with creating revenues in the current period should be treated as operating expenses. Expenses that create benets over several periods are written off over multiple periods (as depreciation or amortization) To get from accounting earnings to cash Fows: you have to add back non-cash expenses (like depreciation) you have to subtract out cash outFows which are not expensed (such as capital expenditures) you have to make accrual revenues and expenses into cash revenues and expenses (by considering changes in working capital). Aswath Damodaran 198 Measuring Returns Right: The Basic Principles Use cash fows rather than earnings. You cannot spend earnings. Use l incremental z cash fows relating to the investment decision, i.e., cashfows that occur as a consequence oF the decision, rather than total cash fows. Use l time weighted z returns, i.e., value cash fows that occur earlier more than cash fows that occur later. The Return Mantra: l Time-weighted, Incremental Cash low Return z Aswath Damodaran 199 Setting the table: What is an investment/project? An investment/project can range the spectrum from big to small, money making to cost saving: Major strategic decisions to enter new areas of business or new markets. Acquisitions of other Frms are projects as well, notwithstanding attempts to create separate sets of rules for them. Decisions on new ventures within existing businesses or markets. Decisions that may change the way existing ventures and projects are run. Decisions on how best to deliver a service that is necessary for the business to run smoothly. Put in broader terms, every choice made by a Frm can be framed as an investment. Aswath Damodaran 200 Here are four examples Rio Disney : We will consider whether Disney should invest in its Frst theme parks in South America. These parks, while similar to those that Disney has in other parts of the world, will require us to consider the effects of country risk and currency issues in project analysis. New Paper Plant for Aracruz : Aracruz, as a paper and pulp company, is examining whether to invest in a new paper plant in Brazil....
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invretA - Aswath Damodaran 194 Back to First Principles...

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