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Capital Expenditures, Depreciation, and Amortization in the Gordon Growth Model

Authors:
  • Sutter Securities Financial Services, San Francisco

Abstract

This article discusses two common errors when calculating terminal value using the Gordon growth model – overstating depreciation in relation to capital expenditures, and overlooking amortization's time limits. For a growing company, normalized capital expenditures must be materially higher than depreciation. Amortization of intangible assets is worth the present value of the future tax benefits and should be excluded from the base on which terminal value is calculated. Instead, the present value of the benefits should be added to enterprise value. Similar adjustments should be made for tax-loss carryforwards, limited-life royalties, and other limited-life income and expenses.
Presentation
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Topics: 1. The perpetual growth rate and firm mortality 2. The relationship between capital expenditures and depreciation 3. The appropriate treatment of amortization 4. Projections, normalization, and steady state growth 5. The trend toward using lower long-term growth rates 6. The relevance of multiples for terminal value
Presentation
Full-text available
This presentation examines several factors that impact terminal value and how to address them: (i) the final year of the projection, (ii) the trend toward using lower long-term growth rates, (iii) the “perpetual” growth rate and firm mortality, (iv) the use of multiples for terminal value, (v) the relationship between capital expenditures and depreciation, and (vi) the appropriate treatment of amortization
Presentation
Full-text available
Topics: 1. The perpetual growth rate and firm mortality 2. The relationship between capital expenditures and depreciation 3. The appropriate treatment of amortization 4. Projections, normalization, and steady state growth 5. The trend toward using lower long-term growth rates 6. The relevance of multiples for terminal value
Presentation
Full-text available
This presentation discusses (i) the relationship between capital expenditures and depreciation; (ii) the appropriate treatment of amortization and other limited life items in a terminal value calculation; and (iii) how changes in the Tax Cuts and Jobs Act of 2017 regarding tax rates, net operating losses, interest deductions, and depreciation write-offs can affect DCF analyses.
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