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Dorothy -

Thanks for buying the book!

NA means not applicable. In the GAAP, or accrual, income statement, investment in fixed capital, to cite one example, is of no consequence. In the defensive income statement, this $131 million investment is a use of cash.

As for interest expense, Wrigley does not pay interest. Hence the "n/a."

The higher the ratio of capital spending to depreciation, the more the accrual income statement overstates a firm's cash-generation ability.

When a company spends $1 million on a building, the cost is depreciated over its expected useful life. So if the accountants decide the building has a 20-year useful life, the annual depreciation charge is $50,000. Every year for 20 years the accrual income statement will include in a charge for $50,000. Some companies treat depreciation as a separate line item, others roll the noncash charge into COGS and SG&A.

The GAAP income statement tries to match sales with expenses. That's GAAP. But in a situation where capex is much bigger than depreciation, a company will look more profitable on an accrual basis than on a cash basis. In our example, the company spends $50,000 on the building; from a cash, or defensive, perspective, the cost is $1 million. Presumably, management bought that second building to generate incremental sales or to cut costs. And the purchase may make sense. But academic research tells us that the more capital intensive the business, the lower its subsequent stock performance.

Interest expense - A direct expense in the defensive income statement. In the enterprising P&L, reverse this charge but then estimate total capital and multiply by the weighted average cost of capital. See pg. 76 to learn more. You may also want to do a Google search for Aswarth Damadoran and use the spreadsheets on his excellent website.

Hewitt
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