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chap 9 - Getting Earnings Right Aswath Damodaran Aswath...

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Aswath Damodaran 1 Getting Earnings Right Aswath Damodaran
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Aswath Damodaran 2 Steps in Cash Flow Estimation n Estimate the current earnings of the firm If looking at cash flows to equity, look at earnings after interest expenses - i.e. net income If looking at cash flows to the firm, look at operating earnings after taxes n Consider how much the firm invested to create future growth If the investment is not expensed, it will be categorized as capital expenditures. To the extent that depreciation provides a cash flow, it will cover some of these expenditures. Increasing working capital needs are also investments for future growth n If looking at cash flows to equity, consider the cash flows from net debt issues (debt issued - debt repaid)
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Aswath Damodaran 3 Measuring Cash Flows Cash flows can be measured to All claimholders in the firm EBIT (1- tax rate) - ( Capital Expenditures - Depreciation) - Change in non-cash working capital = Free Cash Flow to Firm (FCFF) Just Equity Investors Net Income - (Capital Expenditures - Depreciation) - Change in non-cash Working Capital - (Principal Repaid - New Debt Issues) - Preferred Dividend Dividends + Stock Buybacks
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Aswath Damodaran 4 Measuring Cash Flow to the Firm EBIT ( 1 - tax rate) - (Capital Expenditures - Depreciation) - Change in Working Capital = Cash flow to the firm n Where are the tax savings from interest payments in this cash flow?
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Aswath Damodaran 5 From Reported to Actual Earnings Update - Trailing Earnings - Unofficial numbers Normalize Earnings Cleanse operating items of - Financial Expenses - Capital Expenses - Non-recurring expenses Operating leases - Convert into debt - Adjust operating income R&D Expenses - Convert into asset - Adjust operating income Measuring Earnings Firm’s history Comparable Firms
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Aswath Damodaran 6 I. Update Earnings n When valuing companies, we often depend upon financial statements for inputs on earnings and assets. Annual reports are often outdated and can be updated by using- Trailing 12-month data, constructed from quarterly earnings reports.
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