# Question on Capitdal Expenditure in FCFE equation

What is the most likely reason that you get an extremely low value from the three-stage FCFE model? Capital expenditures are significantly: A) higher than depreciation in the stable-growth phase. B) less than depreciation during the high-growth phase. C) higher than depreciation during the high-growth phase. Your answer: C was incorrect. The correct answer was A) higher than depreciation in the stable-growth phase. If capital expenditures estimates are significantly higher than depreciation for the stable growth period, then the three-stage FCFE model might result in an extremely low value. One possible solution for the problem is to grow the capital expenditures more slowly than deprecation in the transition period to narrow the difference. Another is to assume that capital expenditures and depreciation will offset when growth normalizes. ---------------- Can someone please help understand why the answer is A and not C? I know that higher capex lowers the FCFE, so got that part. But how do you know it’s during stable growth phase and not high growth phase? I chose C because in the stablization phase your capex stabalizes at a long run level but it is during the growth phase that you have significant capital requirements.

1. High growth phase - you would definitely be investing in FCInv. 2. As a result of that FCFE would not be a good measure, as well. So it has to be stable growth phase. Also remember the FCFE = NI - (1-DR)[FCInv-Depr+WCInv] approach usually this is applied when company is stable - DR ==> stable and predictable. FCInv - Depr = Incremental Investment in FC above maintenance deprecation… both of which are stable company phenomenon.

I think it is a bad question. I would have answered it C myself. But, now that i know A is correct, i would say, for a company having high Capital Expenditures compared to its depreciation AND is in a high-growth phase, using FCFE for valuation is not correct anyways. We know FCFE will be low (most likely be negative) and will not evaluate the firm appropriately. This is the best i can justify A against C.

Why are you guys both saying FCFE is not a good measure in the growth phase? Also CPK, I don’t see your logic in why it should be stable phase. When you write “High growth phase - you would definitely be investing in FCInv” it seems to reaffirm that the high capex occurs in the high growth phase? Lastly, we know that capex goes from high to less to low in the three phases (growth, transition, maturity). What is the typical order for depreciation?

Ill throw a diff spin. Presumably the stable growth stage results in terminal value, and terminal value accounts for 70+ % of value.

The High CAPEX occurs in High growth phase - so you WOULD NOT USE FCFE as a measure. That is also a Big given.

Damn, I fell for the C trap!

Totally fell for the trap - I would have picked C as well.

Warm it up Kris I’m about to Warm it up Kris cause that’s what I was born to do

LOL - I’ve gotten that for what seems like my whole life.

rus1bus Wrote: ------------------------------------------------------- > I think it is a bad question. I would have > answered it C myself. > > But, now that i know A is correct, i would say, > for a company having high Capital Expenditures > compared to its depreciation AND is in a > high-growth phase, using FCFE for valuation is not > correct anyways. We know FCFE will be low (most > likely be negative) and will not evaluate the firm > appropriately. > > This is the best i can justify A against C. I agree. You do not want to use the FCFE as a measure of value if FCFE is negative (which it would be in the high growth phase when capex is greater than dep). But if you say we should avoid negative FCFE in the high growth phase, why can we use it in the stable growth phase, being that your answer is the fcinv is greater than dep in the stable phease?