Research and Development Expenses: Implications for Profitability Measurement and Valuation

25 Pages Posted: 7 Nov 2008  

Aswath Damodaran

New York University - Stern School of Business

Date Written: 1999

Abstract

Most valuation models begin with a measure of accounting earnings to arrive at cash flow estimates. When using accounting earnings, we implicitly assume that the income is obtained by netting out only those expenses that are operating expenses, i.e., expenses designed to generate revenues in the current period. Expenses that are intended to provide benefits over multiple periods are assumed to be considered as capital expenditures, andthese expenses are depreciated or amortized over multiple periods. In addition, whencomputing profitability measures such as return on equity and capital, we stick with this assumption that operating income measures income generated by assets in place. In this paper, we examine the accounting treatment of research and development expenses, and the effects of the treatment on operating income, capital and profitability. We argue that research and development expenses should be treated as tax-deductible capital expenditures, for purposes of valuation, and this can have significant effects on operating income, capital and expected growth measures for firms with substantial research expenses.

Suggested Citation

Damodaran, Aswath, Research and Development Expenses: Implications for Profitability Measurement and Valuation (1999). NYU Working Paper No. FIN-99-024. Available at SSRN: https://ssrn.com/abstract=1297092

Aswath Damodaran (Contact Author)

New York University - Stern School of Business ( email )

Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States
212-998-0340 (Phone)
212-995-4233 (Fax)

HOME PAGE: http://www.damodaran.com

Paper statistics

Downloads
2,438
Rank
3,917
Abstract Views
14,821