Are Capital Expenditures, R&D, Advertisements and Acquisitions Positive NPV?

Abstract

Despite evidence on differences in how classes of investments correlate with present and future firm returns (Titman and Xie 2004; Eberhart et al, 2004), the literature does not yet show whether net present values across investment classes, imputed from contemporaneous firm returns, are distinct from the effects of measurement conservatism of assets in place. In this paper, I extend Easton and Pae (2004) to examine how, distinctly from measurement conservatism, investors’ NPV expectations vary across (i) GAAP-expensed and GAAP-capitalized investment classes and (ii) within these classes, across firm-level conditions associated with value/growth, profit/loss and net financial leverage levels. I find that, while NPV’s vary in the order of risk associated with respective investment classes, significant variation in NPV is driven by firm level conditions. These variations relate to other, non-financial information associated with high growth firms (Donelson and Resutek, 2012), greater value in capacity-expanding investments in loss making firms and higher NPV from investments in firms with negative financial leverage. The results in this study will thus assist analysts evaluating NPV from firm-specific investments to control for the influence of measurement conditions of existing assets and better evaluate reliability of investments’ NPV due to variation in firm-level conditions.

Keywords: Real Investments, Measurement Conservatism, Firm-level conditions

JEL Classification: G12