Growth Capital Expenditure

CFA Level II Corporate Finance
#1

A company will initially outsource its electric scooter parts. But manufacturing these parts in-house beginning in 2016 will imply changes to an existing factory. This factory cost €7 million three years ago and had an estimated useful life of 10 years. Fromm is evaluating two scenarios:

Scenario 1: Sell the existing factory for €5 million. Build a new factory costing €30 million with a useful life of 10 years.

Scenario 2: Refit the existing factory for €27 million.

Fromm’s estimate of growth capital expenditure included in the company’s property, plant, and equipment under Scenario 2 should be:

A. lower than under Scenario 1. B. the same as under Scenario 1. C. higher than under Scenario 1.

The answer is C. This is the book’s explanation. In Scenario 2, growth capital expenditure of €27 million for the refit of the existing idle factory is higher than the growth capital expenditure in Scenario 1 of €25 million. The €25 million is the cost of building a new factory for €30 million less the proceeds from the sale of the existing idle factory of €5 million.

Can someone please explain better than the book on why the answer is C. For Scenario 2, I don’t understand how the entire 27 million can be considered ‘growth’ capital expenditure. Shouldn’t growth capital expenditure be 27 million minus the depreciation in the three years of the old asset? Please help. Thank you!

#2

Growth CapEx is what u incur over maintenance CapEx, for which depreciation is taken as proxy.

Now you r using existing assets and spending 27 MM just to refit them, which means whatever expenditure you had to do towards maintenace of thos assets, u will still have to do, which would be your maintenance CapEx, which is roughly the depreciation expense. Hence 27 mm is entirely the growth capex

#3

Thanks, another question. How would we know if “refitting” includes maintenance or not? Refitting is a pretty broad term. So, couldn’t one argue that out of the 27 MM, 2.1 MM went to maintain (i.e. that is replace the depreciation) and only the rest is growth CapEx? Please let me know thanks.

#4

I was actually confused on this as well, but I was confused by scenario 1. I thought that the entire 30m would be considered “growth capex”. For the purposes of this exam, does growth capex = capex - PP&E sales?