chap 10 - From Earnings to Cashflows Aswath Damodaran...

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Aswath Damodaran 1 From Earnings to Cashflows Aswath Damodaran
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Aswath Damodaran 2 What tax rate? n The tax rate that you should use in computing the after-tax operating income should be o The effective tax rate in the financial statements (taxes paid/Taxable income) o The tax rate based upon taxes paid and EBIT (taxes paid/EBIT) o The marginal tax rate o None of the above o Any of the above, as long as you compute your after-tax cost of debt using the same tax rate
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Aswath Damodaran 3 The Right Tax Rate to Use n The choice really is between the effective and the marginal tax rate. In doing projections, it is far safer to use the marginal tax rate since the effective tax rate is really a reflection of the difference between the accounting and the tax books. n By using the marginal tax rate, we tend to understate the after-tax operating income in the earlier years, but the after-tax tax operating income is more accurate in later years n If you choose to use the effective tax rate, adjust the tax rate towards the marginal tax rate over time.
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Aswath Damodaran 4 A Tax Rate for a Money Losing Firm n Assume that you are trying to estimate the after-tax operating income for a firm with $ 1 billion in net operating losses carried forward. This firm is expected to have operating income of $ 500 million each year for the next 3 years, and the marginal tax rate on income for all firms that make money is 40%. Estimate the after-tax operating income each year for the next 3 years. Year 1 Year 2 Year 3 EBIT 500 500 500 Taxes EBIT (1-t) Tax rate
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Aswath Damodaran 5 Net Capital Expenditures n Net capital expenditures represent the difference between capital expenditures and depreciation. Depreciation is a cash inflow that pays for some or a lot (or sometimes all of) the capital expenditures. n In general, the net capital expenditures will be a function of how fast a firm is growing or expecting to grow. High growth firms will have much higher net capital expenditures than low growth firms. n Assumptions about net capital expenditures can therefore never be made independently of assumptions about growth in the future.
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Aswath Damodaran 6 Capital expenditures should include n Research and development expenses , once they have been re- categorized as capital expenses. The adjusted net cap ex will be Adjusted Net Capital Expenditures = Net Capital Expenditures + Current n Acquisitions of other firms , since these are like capital expenditures. The adjusted net cap ex will be
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chap 10 - From Earnings to Cashflows Aswath Damodaran...

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