Hi WSO - Quick Question.
Say I use 100 in cash to purchase operating PPE. Using the Equity value to EV bridge formula, my EV would go up because I converted a non-operating asset to an operating asset (i.e. cash to PPE). Equity value would remain the same.
If I then think about this in terms of an unlevered DCF, it seems like the capex spend would decrease my FCFs, and thus the PV of my FCFs would be lower, and so my EV would be lower. I understand that the capex would theoretically increase my growth rate etc because hopefully it was a good investment, but I'm struggling with reconciling the bridge which says my EV is higher, and the DCF which seems to say my EV is lower. Can you tell me what I'm missing, unless the increase in FCF growth due to productive capex investment is essentially why my bridge says my EV is higher.
Thanks in advance.
Assuming the value of the PPE doesn't change immediately, i.e no depreciation. The overall value doesn't change unless you model in changes in future cash flows. Cash is included implicitly in the market cap, hence when a company pays dividends the market cap falls.
If you model in future cash flows as long as the NPV is > 0 then theoretically the EV will increase as the PV of the future cash flows is > than the initial investment in CapEx.
The growth rate isn't just a hypothetical element to your DCF. If the capex is not required to achieve the growth, the company will not do it. Or the other way around: if the capex does not result in a return that exceeds the WACC, its value destroying (NPV 0).
If RONIC on capex > WACC, the investment will increase EV.
Your DCF before the investment should already incorporate that the company has a backlog or needs expansion capex to achieve the growth. If it buys 100 of assets to expand into a new business, those assest shouls generate additional free cash flow.
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