Hi,
Could someone please elaborate on what the meaning of capex = depreciation would be. What would the meaning be if capex is higher or lower than depreciation?
Many thanks
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I think you might be referring to the terminal period.
In the terminal period you want to make sure that CAPEX is larger than or equal to depreciation. If depreciation is larger than CAPEX in the terminal period, you are assuming that your fixed asset base is being depreciated out and you will run out/don't need fixed assets in the terminal periods (all businesses need fixed assets).
Right. At the terminal period, ideally, the company is at steady state. So you don't want capex depr or extremely > depr because that would imply that the company's asset base is decreasing or increasing to infinity.
I interpreted your question differently than the above posters (their comments are spot on if you're thinking about modeling).
If capex=depreciation, it means that the company does not need to plow money into PPE (capex) above replacement (depreciation)... In most cases, there will be inflation that causes capex to be higher than depreciation even if it's only replacing old PPE.
If you're interested in how this plays out in the real world, I would recommend reading Warren Buffet's rationale behind purchasing the Berkshire textile mill. Specifically when he explained to the manager of the mill why capex would be reduced even thought it would impede future revenue.
Love that you've picked up on the inflation consideration. Still just a student?
Yes, I am for the next month or two at least.
Where can I read up on this? I have exactly the same problem
http://www.berkshirehathaway.com/letters/1985.html
Question on capex and depreciation (Originally Posted: 12/09/2017)
When modeling out unlevered free cash flow, should capex be set equal to depreciation? Would a model that has capex consistently lower than depreciation be correct?
Normally it's set equal to depreciation
I’d put Capex as a % of sales, and depreciation as a % of PP&E, and keep those constant over time.
if you are reducing your investment in PPE, CapEx can be lower than D&A, but on the long-run they are going to be balanced.. but in general I would try to keep D&A=CapEx
for modelling purpose, it doesn't matter much. you are not projecting out 100 years. as long as you don't let depreciation to result in a negative or drastic yoy reduction in net PP&E, it should be fine. it's ok to have net PP&E decrease, as depreciation itself is an arbitrary thing based on management's judgement of the useful life of the hard assets, etc.
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