On the forecasting of lease expense in firm valuation
The forecasting of operating lease expense in valuation models like the discounted dividends model is more complex than the forecasting of non-lease cash operating expense. The reason is that lease expense depends on past real growth and inflation, due to the long lives of the leased assets, whereas non-lease cash operating expense depends only on this year's nominal sales revenue. Naive forecasting (as if lease expense depends only on current nominal sales revenue) can have a noticeable impact on the calculated value of the equity, if the company is a heavy user of leased equipment and has experienced rapid real growth in recent years. It is shown how lease expense can be forecasted, without capitalizing, in a fashion that does take into account the dependence on past real growth and inflation. Operational leases also affect the cost of capital for discounting, since they represent debt, even if not capitalized. Hence they enter into the financing structure that goes into the cost of capital. An illustrative stylized example is used throughout.
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|Date of creation:||29 Jun 2009|
|Date of revision:||02 Dec 2009|
|Publication status:||Published as Jennergren, L. Peter, 'On the Forecasting of Net Property, Plant and Equipment and Depreciation in Firm Valuation by the Discounted Cash Flow Model' in Journal of Business Valuation and Economic Loss Analysis, 2010.|
|Note:||The first part of this working paper has been revised and published. The second part of this working paper has been revised and put into S-WoBA 2011:3.|
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- Jennergren, L. Peter, 2004. "Continuing Value in Firm Valuation by the Discounted Cash Flow Model," SSE/EFI Working Paper Series in Business Administration 2004:15, Stockholm School of Economics.
- Jennergren, L. Peter, 1998. "A Tutorial on the Discounted Cash Flow Model for Valuation of Companies," SSE/EFI Working Paper Series in Business Administration 1, Stockholm School of Economics, revised 22 Jun 1999.
- Jennergren, L. Peter, 2008. "Continuing value in firm valuation by the discounted cash flow model," European Journal of Operational Research, Elsevier, vol. 185(3), pages 1548-1563, March.
- Yard, Stefan, 2004. "Costing fixed assets in Swedish municipalities: Effects of changing calculation methods," International Journal of Production Economics, Elsevier, vol. 87(1), pages 1-15, January.
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