year’s entire R&D expense to arrive at the value of the
researchasset.Thisaugmentsthevalueoftheassetsofthe
firm and, by extension, the book value of equity.
Finally, the operating income is adjusted to reflect the
capitalizationofR&Dexpenses.First,theR&Dexpensesthat
were subtracted out to arrive at the operating income are
added back to the operating income, reflecting their
recategorizationascapitalexpenses.Next,theamortizationof
theresearchassetistreatedthesamewaythatdepreciationis
and netted out to arrive at the adjusted operating income.
The adjusted operating income will generally increase for
firmsthat haveR&Dexpenses thataregrowingovertime.
The net income will also be affected by this adjustment:
Whilewewouldnormallyconsideronlytheafter-taxportion
ofthisamount,thefactthatR&Disentirelytax-deductible
eliminates the need for this adjustment.
1
ILLUSTRATION3.2:CapitalizingR&DExpenses:Ciscoin
2005
Cisco,asaleadingtechnologyandsoftwarecompany,invests
considerableamountsinresearchanddevelopmenteachyear.
In the most recent fiscal yearended July 2005, the R&D