Aswath Damodaran Session 8: From Earnings to Cash Flows

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Published on Oct 5, 2016

Today's class covered a lot of topics, some related to cash flows and some related to growth. Let's start with the cash flow part first. I argued that capital expenditures should be defined broadly to include R&D and acquisitions, for consistency reasons. If you want to count the good stuff (growth) that comes from these investments, you have to also count the cost. To get from cash flow to the firm to cash flow to equity requires us to bring in cash flows to and from debt. While borrowing more can make your cash flows to equity higher, they also make your equity riskier, raising the cost of equity. The net effect of leverage on the value of equity can be positive, negative or neutral, depending on the firm and where it is in its borrowing cycle. On growth, we started with historic growth and quickly dispensed with the notion that it is a fact. Depending on how it is estimated (arithmetic vs geometric) and over what period, you can get different numbers. It is also thrown off when a company's earnings go from negative to positive and generally becomes lower as companies get larger. I also mentioned forensic accounting in the context of accounting game playing. While truly extraordinary items are easy to deal with, accounting ploys to move expenses into the extraordinary column may require some detective work.

Start of the class test: Informal (no slides)


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