Hi folks,
when calculating the capital expenditures do we have to consider ONLY the investment in fixed asset (CapEX), or BOTH CapEx and acquisition of businesses?
My concern is that CapEx are real cash outflow, while acquisition of businesses (for example oil ang fields) are reported on the CF/S net of cash and may consist of pretty much goodwill which is a non-cash charge and subject to impairment.
I thought it is a fairly simple practical question. Now it seems like a million dollar question… =)
I’m sure though that someone hier knows the answer
Hi,
For LT growth, i would say no. For short term (1 - 5y) i d say yes if acquisition is Part of the company growth strategy.
In theory, the CapEx included in FCFF and FCFE should be only the capital expenditures required to maintain the company at its current size (output); any capital expenditure to increase (or decrease) the size of the company is considered a _ use _ of FCF.
In practice, most companies don’t segregate capital expenditures between those to maintain current output and those that change the output of the company.
CapEx has to do with maintaining the fixed assets, fixing of transport vehicles, replacement of old machines with new ones etc. and acquisitions dont necessarily form part of it.
im not sure if in practice, capex and acqs are segregated or not, but for exam purposes, i havent come across a question as of yet which included acqs in fcfe or fcff calculations. if i do come across acq in fcff or fcfe question, ill post a reply or start a new thread.
Interesting question!
Is the conclusion then that in theory capex is only expenditures used to maintain what the company currently is doing and any expenditures used for the growth of the company would fall under the use of FCF?
Yes.
Note that if the company is contracting, the CapEx _ use _ of FCF would be negative; i.e., you would have to use a _ higher CapEx than was actually spent _ to compute FCF.
As I mentioned above: in practice, most companies don’t do this. They use actual CapEx to compute FCF, despite it being incorrect in theory.
Thank you so much guys for the answers!
I am asking from a practical point of view. It seems that in practice there is no common understanding because in the CFA books there is not a single word about acquisition and sale of businesses.
I am, however, feeling that not accounting for acquisitions/dispositions is inappropriate. Any business you purchase has to be financed either by self-generated cash, debt or equity. Say you buy a business for 100 units but you dont have cash and issue debt. What do we get learnt by CFA in calculating FCFE? Add the net debt +100 units but what about the business urchase? We are considering only one side of the equation.
Damodaran points out that we have to add any acquisition to CapEx. That’s why I felt confused and opened the thread.
All that being said, I should consider acquisitions/dispositions of assets when computing FCFF/FCFE. It gets really ugly, especially for the companies in the natural resources industry but what else…
We use FCFF to value the firm, so why whould we add CAPEX related to adquisition of new business? Rather, I would add the expected incremental FCFF of the new business line to the existing FCFF. That will surely increase the value of the firm (reflects the adquisition value).
FCFF = NI + NCC + int(1 - tax rate) - FCInv - WCInv, this should only consider the existing business operations and only the investments related to those business operations.
What about the argument that the acquisition is cash outflow and reduces the value (or the FCFF) attributable to share and debtholders? It’s cash that has gone no matter how you call it - CapEx or business acquisition.
Actually, this is just important for the past calculation of the FCFF. If you calc future FCFF you will barely know what the firm is planning one year ahead. Hence, the assumption would be that no business is acquired (unless announced by the company) and CapEx remains the only variable. I think that’s the expected incremental FCFF Harrogath is talking about.
What about sale of business? should we decrease the investing cash flow by the amount sold? I think the same logic is applicable for sales as well, though with opposite sign.
Be careful in the difference between FCFF and firm value. The first one is simply cash flow, the second one is the present value of those expected cash flows. I agree that acquisition is cash outflow, however, it does not reduce the value of the firm. Note that the FCFF formula provided by CFAI does not consider acquisitions, so I suppose acquisitions must be recorded by the incremental FCFF they generate (this is how we value projects). If the present value of cash flows are higher than the amount invested, positive value is created, if not, loses may be taken.