LBO Model: Depreciation in Cash Flow Statement
I'm working through the example lbo model in the Rosenbaum & Pearl book, and I'm getting confused by the investing activities section of the cash flow statement.
The book reads: "The target's projected net PP&E must incorporate the capex projections (added to PP&E) as well as those for depreciation (subtracted from PP&E).
Why would you subtract depreciation from the investing activities? I understand why we add depreciation to operating activities, but this point is lost on me.
Presumably we aren't spending cash to repair PPE every year. And our cash on hand should be higher than net income by the amount of depreciation because it is noncash. So by subtracting depreciation from investing activities our ending cash balance will reflect our (artificially low) net income.
Is this a nuance of LBO modeling, or is there some accounting here that I'm missing?
Sounds like you're misreading. Post the whole passage.
Sure thing. See below:
Investing Activities Capex is typically the key line item under investing activities, although planned acquisitions or divestitures may also be captured in the "other investing activities" line item. Projected capex assumptions are typically sourced from the CIM and inputted into an assumptions page (see Exhibit 5.52) where they are linked to the cash flow statement. The target's projected net PP&E must incorporate the capex projections (added to PP&E) as well as those for depreciation (subtracted from PP&E). As discussed in chapter 3, in the event that capex projections are not provided/available, the banker typically projects capex as a fixed percentage of sales at historical levels with appropriate adjustments for cyclical or non-recurring items.
The sum of the annual cash flows provided by operating activities and investing activities provides annual cash flow available for debt repayment, which is commonly referred to as free cash flow (see Exhibit 5.25).
As shown in exhibit 5.8, we do not make any assumptions for valuCo's other investing activities line item. Therefore, ValueCo's cash flow from investing activities is equal to capex in each year of the projection period."
It's telling you how to look at long-term capital on your BS in your projection period. Fixed assets are essentially PP&E+Capex-Dep
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