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Memo. 1965-200. As the need for current assets to operate the
business increases, cash available to equity holders decreases;
that is, increases to net working capital result in decreases to
net cash-flow. As for long-term debt, as Mr. Pratt pointed out
in testimony and in his report, when considering cash-flow to
both the equity and debt holders, net changes in long-term debt
should not be considered; increases in debt do not increase cash-
flow to the debt holders, since they themselves supplied the
cash. However, net changes in long-term debt must be considered
when considering cash-flow to equity only, because proceeds
received as debt are available as cash-flow to the equity
holders. Respondent argues that there should be no reduction for
long-term debt. However, because the stock in issue represents
an equity investment in Dunn Equipment, the proper earnings base
will reflect the projected income stream to an equity investment
in the company. Both Mr. Pratt and Ms. Eggleston correctly
stated that the relevant earnings base in the instant case is net
cash-flow to equity, not to the entire enterprise. Thus, it is
proper to consider net changes in long-term debt.
Finally, there is the question of using a weighted average
rather than a straight average to calculate net cash-flow to
equity.6 Mr. Pratt would have used a weighted average, and,
6 In a typical 4-year weighted average, the most recent year
is given a weight of four, the previous year three, then two,
(continued...)
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