Operating leases and R&D question
I ran into this http://pages.stern.nyu.edu/~adamodar/New_Home_Pag… while building a DCF model. Damoradan says, in his response to question #1, that the EBIT listed on the income statement must be adjusted as operating leases and R&D are not operating expenses. Searching WSO, I came across this thread //www.wallstreetoasis.com/forums/operating-leases which has a post by cdnbanker that goes:
"The OP is referring a technique of standardizing EBITDA some valuation methods call for in order to create more comparability between companies that borrow money to buy their PP&E and companies that rent their PP&E. In that case, capitalized operating leases are just treated like debt, and thus included in EV.
But as hardbanker mentioned, this is a theoretical approach rarely seen in practice in IB. In most cases, we just use the quick-and-dirty method of looking at EBITDAR (R = rent). Hope this helps."
Does this mean that in practice in IB one would adjust net income listed on the income statement by adding back R&D and operating lease costs to arrive at EBIT used in FCF (and if R&D is a capex, wouldn't it be cancelled out if one added it to to both net income and capex in EBIT(1-t) + D&A - capex - delta working capital? If not, someone please enlighten me about their quick-and-dirty method, because that's how I like it.
I guess this question would be easier to answer if I could show you a model and how it works, but hopefully you can follow. The R&D wouldn't be cancelled out because you're going to remove it from teh income statement and make it capex. The idea is to treat R&D just like you treat PP&E. So it goes into capex and gets amortized over the valuable life of the research. Does PP&E get cancelled out? No, the amortization of teh R&D gets cancelled out but it still shows up in the capex as far as your free cash flows.
As far as operating leases, the quickest way, imo, is to just treat capitalized leases like debt, that way it makes it more apples to apples. Often, you have to go digging through 10-K to find operating leases whereas capital leases will show up on the balance sheet. Try it a few times with a few different companies; I think you'll find that adding cap leases as if they're debt is much easier than trying to find an EBITDAR (and EBITDAR is more for industries with a heavy real estate component, since usually the rent they're referring to is more akin to renting property, not equipment).
So I add R&D back to operating profit, then amortize it over what I think the valuable life of the research is (any tips on how I should choose such a length? Let's say I choose 5 yrs - if R&D is 100, then I have amortization of 20/yr, correct?). Then, I add R&D to capex and the amortization of R&D to my depreciation/amortization value?
Aren't operating leases different than capital leases?
Also, I'm a little confused about how to interpret the 10-K reporting of operating leases. Operating leases are listed by Payment Due By Period and there is total, WACC, correct? Operating lease would then be my market value of debt... but what about cost of debt? The company I'm valuing technically has a AAA rating because it has an infinite interest coverage ratio. Do I use cost of debt that reflects AAA, or do I downgrade to AA (comparable company has AA rating w/ debt)?
A lot of questions.
Thanks for your help.
Anyone? I'm desperate and on a deadline.
bump!
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