1999
Aswath Damodaran
ABSTRACT
Most valuation models begin with a measure of accounting earnings to arrive at cash flow estimates. When using
accounting earnings, we implicitly assume that the income is obtained by netting out only those expenses that are
operating expenses, i.e., expenses designed to generate revenues in the current period. Expenses that are intended
to provide benefits over multiple periods are assumed to be considered as capital expenditures, and these expenses
are depreciated or amortized over multiple periods. In addition, when computing profitability measures such as
return on equity and capital, we stick with this assumption that operating income measures income generated by
assets in place. In this paper, we examine the accounting treatment of research and development expenses, and the
effects of the treatment on operating income, capital and profitability. We argue that research and development
expenses should be treated as tax-deductible capital expenditures, for purposes of valuation, and this can have
significant effects on operating income, capital and expected growth measures for firms with substantial research
expenses.
Damodaran: (212) 998-0349 adamodar@stern.nyu.edu
To download a copy of this paper click here
To request a copy of this paper click here
The Finance Department Working Paper Series has been generously sponsored by