Why CAPEX=D&A in the terminal year of a DCF?
Hi,
why do you assume a constant capital basis (i.e. Capex=D&A) from the terminal year of your projection period onwards? After all a growth rate is added to the FCF of the terminal year which then is treated as a perpetuity [FCF * (1+g) / (WACC - g)]. Wouldn't it be justifiable to assume a growing capital base in order to support this growth?
In my opinion, It is just too hard to model assets in the long run. Sure you probably need more assets to justify growing cash flows or margins could improve.
In the long run the CapEx is more like maintenance CapEx because it's just impossible to make valid projection at that point
Try these two exercises:
Compare your perp growth rate to the company's actual historical growth rate. If you're doing it right, the former will be a fraction of the latter. Perpetuity growth usually = inflation, implying that real growth is zero. So capex should not exceed D (forget A - that's different) because that would imply you're deploying capital to investments that won't create growth
Run out your model with a more aggressive perp. growth rate. What you'll see is that this company of yours is on track to constitute about 1/3 of global GDP 50 years from now. I'm exaggerating of course, but perpetuity is a long time.
You mean the perp. growth rate should be a fraction of the actual historical growth rate, right? As you've stated it the other way around.
Good catch - since edited. Yes: The perp growth rate will be very small relative to the growth rate for the historical and near-term projected period.
Aside from the obvious disclaimer that every company is different, no I don't agree that a growing capital base is generally necessary for additional growth. A business that changes nothing at all should still have some growth just from inflation.
Hey, what's driving this question? Are you in school? Real world sell side you want to use an income statement multiple.
Recently finished my MSc and am starting an m&a- internship in 4 weeks from now.
What are you referring to with your last sentence - calculating the final year FCF or the terminal value?
I'm saying that market practice is doing a DCF to the out years (where you have line of sight) THEN assume that a company will be worth around an industry market multiple. So in year 10 the terminal value will be EBITDA x 8 to 13 or NI x 15 o r 20. Obviously, you'll need to make sector adjustments. You're better off just going out another 10yrs than you are assuming and arbitrary rate of perpetual growth.
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