Boyd,
Sorry for the delay in getting back to you. As you may know, I have had a number of "non-TNL" projects to complete during April, as well as a number of "Updates" to turn out...
You had several questions about "the derivation of the NPV of 12.60/share for KAB using discounted cash flows", as follows:
"1) Why don't you include some measure of capital expenditures in your
calculation of cash flow? If you add back depreciation and amortization, why shouldn't Cap Expenditures be subtracted from net income??"
Capital expenditures represent an actual cash outlay, whereas depreciation and amortization are accounting requirements to reflect cash outlays which were made in the past. Similarly, a capital expenditure reflects a management decision to add additional capacity in order to produce future growth, whereas depreciation and amortization represent the "costs" of current capacity, even though these costs are "non-cash" in nature. Conceptually, the two are quite different. Of course, in an in-depth acquisition analysis, projected future capital expenditures are definitely taken into account.
"2) Do you believe that changes in ST assets and liabilities (AKA changes in Working Capital) should be excluded from the cash flow calculation? and why?"
Working Capital changes generally reflect management decisions (or management competency), and are not a reflection of the inherent business itself. In other words, future growth might bring changes in AR, inventory and AP, but effective management should be able to balance the growth in each, with the help of short-term borrowing if needed.
"3) What about the costs of interest/borrowing expenses? In 1997, KAB
paid out nearly 15.5 million in interest (from the income statement).
However, in looking at the cash flow statement, the company actually paid down its LT debt by 4.149 million! I'm not quite sure how to account for this in a cash flow model--how do you account for it, if at all??"
I do account for interest, but as a static expense, rather than dynamically "flexing" it to reflect the impact of future cash flows, because I think that this is a more conservative approach. In other words, if interest expenses are $15,381,795 in year one, as they are in the KAB model, they remain at $15,381,795 million for the entire period of the NPV calculation. Once again, increases in interest expense are probably the result of management decisions or economic changes, rather than the inherent nature of the business.
"4) It looks like you DON'T use fully diluted shares outstanding when
calculating your final NPV. Why?? And should one use the most current
number for outstanding shares (as of the day of the 10K) or a weighted
average over the course of a year or quarter?"
Normally I use fully diluted shares outstanding in all of my calculations, although I did not do so for the KAB Analysis. However, the effects of dilution are very small and increase the share-count by only 1.7%.
Bob Davis
The Napeague Letter
napeague.com |
