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Valuation Workbook: Step-by-Step Exercises and Tests to Help You Master Valuation, 5th Edition by McKinsey & Company

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27

Leases, Pensions, and Other Obligations

Leases, pension obligations, and securitized receivables are like debt obligations, but accounting rules can allow them to be off-balance-sheet items. Such items can bias ROIC upward, which makes competitive benchmarking unreliable; however, valuation may be unaffected.

To adjust for operating leases, the analyst should (1) recognize the lease as both an obligation and asset on the balance sheet (which requires an increase in operating income by adding an implicit interest expense to the income statement and lowering operating expenses by the same amount), (2) adjust WACC for the new leverage ratios, and (3) value the company based on the new free cash flow and WACC. Assuming straight-line depreciation, an estimate of a leased asset's value for the balance sheet is:

Unnumbered Display Equation

Another source of distortion occurs when a company sells a portion of its receivables and thereby reduces accounts receivable on the balance sheet and increases cash flow from operations on the cash flow statement. Despite the favorable changes in accounting measures, the selling of receivables is very similar to increasing debt, because the company pays fees for the arrangement, it reduces its borrowing capacity, and the firm pays higher interest rates on unsecured debt. The information to make adjustments should appear in the footnotes to company accounts. The analyst should ...

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