4. Siago Pharmaceuticals is a mature company whose R&D Expenses have decreased f

Question

4. Siago Pharmaceuticals is a mature company whose R&D Expenses have decreased from $400 million five years ago to $200 million in the most recent year. The company reported operating income of $500 million in the most recent year. If you capitalize R&D expenses, which of the following would you expect to see happen to your adjusted numbers?

a. Operating income will increase, FCFF will decrease

b. Operating income will decrease, FCFF will decrease

c. Operating income will increase, no change in FCFF

d. Operating income will decrease, no change in FCFF

e. Operating income will increase, FCFF will increase

f. Operating income will decrease, FCFF will increase

Explanation / Answer

If you capitalise R&D expenses the capitalised R&D expenses in the recent year shall become lesser than if the whole R&D expense was expensed therefore the overall expense shall decrease when R&D expense is capitalised as compared to when its expensed fully therefore Operating income will increase.

FCFF shall remain unchanged(The cash movement is nil. due to capitalising) as the operating cash flow shall increase by the same amount as there is increase in the capital expenditure therefore both shall offset each others effect and overall value of FCFF which is  operating cash flow minus  capital expenditure shall remain unchanged.

Thus right option is c. Operating income will increase, no change in FCFF.

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