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Category: Business and Industry
Date Submitted: 04/12/2011 04:07 PM
FINANCIAL INFORMATION ANALYSIS
ACCOUNTING-BASED VALUATION TECHNIQUES
Application Exercises
Question 2
Construct a two-period numerical example to show that the accounting-based valuation of a firm is the same whether R&D is capitalized or expensed.
ACCOUNTING-BASED VALUATION TECHNIQUES
Application Exercises
Question 2
Consider R&D Inc., a biotech start up. This firm:
• Incurs expenditures in R&D of $50 in the first year of activity;
• Has an opening book value of equity of $1,000;
• Generates income (before R&D expenses) of $200 in year 1 and $220 in year 2, at the end of which it is liquidated;
• Has a cost of equity capital of 10%;
• Pays no dividends prior to liquidation;
Show that the PVAE obtains regardless of whether R&D Inc. expenses R&D expenditure as incurred or capitalizes and amortizes R&D expenditure!
ACCOUNTING-BASED VALUATION TECHNIQUES
Application Exercises
Question 2
Expensing R&D As Incurred
Assume that the R&D expenditure is expensed at the end of year1:
[pic]
And Thus:
PVAE = 1132.2
ACCOUNTING-BASED VALUATION TECHNIQUES
Application Exercises
Question 2
Capitalising And Amortising R&D (1)
Assume that the R&D expenditure is capitalised and amortised linearly:
• R&D expense recognised at end of year 1: 25;
• R&D expense recognised at end of year 2: 25;
[pic]
And thus:
PVAE = 1132.2
ACCOUNTING-BASED VALUATION TECHNIQUES
Application Exercises
Question 2
Capitalising And Amortising R&D (2)
Assume that the R&D expenditure is capitalised and amortised as follows:
• R&D expense recognised at end of year 1: x;
• R&D expense recognised at end of year 2:
• 50-x;
[pic]
ACCOUNTING-BASED VALUATION TECHNIQUES
Application Exercises
Question 2
Capitalising And Amortising R&D (3)
As:
[pic]
PVAE is thus independent of x and hence accounting policy for R&D expenditure!
FINANCIAL INFORMATION ANALYSIS
ACCOUNTING-BASED VALUATION TECHNIQUES...