Dealing with Operating Leases in Valuation

25 Pages Posted: 7 Nov 2008

See all articles by Aswath Damodaran

Aswath Damodaran

New York University - Stern School of Business

Date Written: 1999


Most firm valuation models start with the after-tax operating income as a measure of the operating income on a firm and reduce it by the reinvestment rate to arrive at the free cash flow to the firm. Implicitly, we assume that the operating expenses do not include any financing expenses (such as interest expense on debt). While this assumption, for the most part, is true, there is a significant exception. When a firm leases an asset, the accounting treatment of the expense depends upon whether it is categorized as an operating or a capital lease. Operating lease expenses are treated as part of the operating expenses, but we will argue that they really represent financing expenses. Consequently, the operating income, capital, profitability and cash flow measures for firms with operating leases have to be adjusted when operating lease expenses get categorized as financing expenses. This can have significant effects not just on valuation model inputs, but also on some multiples such as Value/EBITDA ratios that are widely used in valuation.

Suggested Citation

Damodaran, Aswath, Dealing with Operating Leases in Valuation (1999). NYU Working Paper No. FIN-99-023, Available at SSRN:

Aswath Damodaran (Contact Author)

New York University - Stern School of Business ( email )

Stern School of Business
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New York, NY 10012-1126
United States
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212-995-4233 (Fax)


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