Asset write-downs occur when the fair value of an asset, what it would fetch on the market, falls below its carrying value, the cost of an asset less accumulated depreciation or amortisation, forcing the book value, what appears on the balance sheet, to be written down, perhaps even completely, to its fair value. Write-downs and write-offs are important signals to debt investors of the deteriorating quality of collateral, but in sending those signals, they muffle another: the historical invested capital put into the business by its shareholders. So, a firm’s return on invested capital (ROIC) rises because invested capital, the denominator in ROIC, is shrunk after a write-down. In effect, this penalises firms with no write-downs when compared with firms with write-downs.
“Asset Write-Downs, a NOPAT Adjustment”, Joseph Noko
To reverse the adulterating impact of asset write-downs, I add back cumulative after-tax asset write-downs to my calculation of invested capital. Given the computational difficulties of doing so for too extended a period, and the utility of doing so, I exercise some judgement to assess how far back this accumulation must go. With regards to the after-tax form of the write-downs, this is because the tax benefits of write-downs are real benefits to the business that allay the destructive impact of the write-downs.