capitalized interest for high growth biz because, business, interest, previously, additional

hinsafdar

"For firms in an expansion phase, capitalizing interest may result in earnings that are higher over many periods compared to an expensing firm because the amount of depreciation from previously capitalized interest is less than the amount of additional interest that is being newly capitalized."

Source: Schweser, SS9 page 167


Question:

For average growth business, capitalizing interest will result in smoother earnings compared to an expensing business for a given period since the amount of depreciation will be expensed over that period. The expensing firm will have lower earnings in the year the interest was expensed and higher earnings in subsequent periods.

In relation to the avg growth business, is the above quote saying that for above avg growth business the earnings will be higher even in the first year? Can someone please interpret the quote as I am not able to understand what do they mean by "...amount of depreciation from previously capitalized interest is less than the amount of additional interest that is being newly capitalized..."

Thanks.

Benjiko

1. if a company capitalizes interest -> it is adding to assets - and is going to depreciate that over time. and typically depreciation expense over time would be less than a 1 time interest expense charge.

2. for a rapidly expanding company - you might typically end up seeing multiple periods in which capitalized interest is added on as an asset to the B/S. In that sense - you would see that the asset figure is growing much faster than the depreciation expense.

that is how I interpret the above.

CP

RobertA

Thanks CP.

What also threw me off was "...earnings that are higher over many periods compared to an expensing firm..".

Your reasoning makes sense to me. Just so that I understand what you are saying allow me to illustrate:

Let's say a high flying firm capitalizes interest 3 times (in year 1, year 2 and year 3) with each having a duration of three years. In order to make sense of "...earnings that are higher over many periods compared to an expensing firm..", the earnings reported under this scenario will be higher for year 1, year 2, and year 3 - but lower if the firm were to expense the interest in each year. So if this continues for some time because of sales growth the earnings will certainly be higher for many periods (although if the firm were to expense the interests, the earnings would be higher in the later periods and eventually the total earnings would be exactly the same).

Is this a proper illustration?