Thanks Adam. How would you think about a company that build say a hydroelectric dam, with a very large initial capital outlay but much smaller ongoing maintenence expenses. Would you just consider the ongoing actual 'property palnt and equiptment' expeses in this case or still factor in depreciation? Thanks.
Great question, Rob. That's one of those special cases. You could put real estate in there too if you were looking at one building perhaps. The key is understanding the economic characteristics of the asset.
A hydro dam is probably a 100 year asset. So maintenance expenses would be expensed on the income statement most likely (I haven't looked at any, just guessing). Now if there are long-lived assets like turbines or something, that might be an expense worth noting/deducting.
In a case like you've just described you'd see all sorts of weird things in the numbers like negative growth capex because depreciation would far outweigh spending in the investing activities section of the CF statement.
Also, book depreciation would soon be almost silly compared to economic reality. A dam built 100 years ago would have a FAR lower book value compared to modern replacement value. Again, the key is understanding the true economics of the situation and how the accounting tells a story (or doesn't).
Thanks very much for the answer. So if you had a company that had the sole operation of owning and operating a hydroelectric dam, built say 10 years ago, would you roughly think I was on the right track by thinking about what it would cost you to buy this company, giving thought to both equity and debt and then how much the operation could generate in cash, which very roughly would be by adding back the full depreciation charge to net income and subtracting what you think would be the ongoing maintenance costs involved with keeping everything in order (if they were not already expensed through the income statement). I'm thinking the initial cost of the Dam (and thus subsequent depreciation) would not be relevant to me as a prospective new purchaser, only what it would cost me to acquire these already existing assets. There are some cases similar to this example in NZ, power generating and retailing companies which seem to trade on multiples to cash flow not earnings, as they have built big projects and have huge depreciation schedules.
Thanks Adam. How would you think about a company that build say a hydroelectric dam, with a very large initial capital outlay but much smaller ongoing maintenence expenses. Would you just consider the ongoing actual 'property palnt and equiptment' expeses in this case or still factor in depreciation? Thanks.
Great question, Rob. That's one of those special cases. You could put real estate in there too if you were looking at one building perhaps. The key is understanding the economic characteristics of the asset.
A hydro dam is probably a 100 year asset. So maintenance expenses would be expensed on the income statement most likely (I haven't looked at any, just guessing). Now if there are long-lived assets like turbines or something, that might be an expense worth noting/deducting.
In a case like you've just described you'd see all sorts of weird things in the numbers like negative growth capex because depreciation would far outweigh spending in the investing activities section of the CF statement.
Also, book depreciation would soon be almost silly compared to economic reality. A dam built 100 years ago would have a FAR lower book value compared to modern replacement value. Again, the key is understanding the true economics of the situation and how the accounting tells a story (or doesn't).
Hope this helps!
Adam
Thanks very much for the answer. So if you had a company that had the sole operation of owning and operating a hydroelectric dam, built say 10 years ago, would you roughly think I was on the right track by thinking about what it would cost you to buy this company, giving thought to both equity and debt and then how much the operation could generate in cash, which very roughly would be by adding back the full depreciation charge to net income and subtracting what you think would be the ongoing maintenance costs involved with keeping everything in order (if they were not already expensed through the income statement). I'm thinking the initial cost of the Dam (and thus subsequent depreciation) would not be relevant to me as a prospective new purchaser, only what it would cost me to acquire these already existing assets. There are some cases similar to this example in NZ, power generating and retailing companies which seem to trade on multiples to cash flow not earnings, as they have built big projects and have huge depreciation schedules.