3.26: Sustaining capital expenditures
In developing a pro forma cashflow statement, a CBV will usually include a cash outflow line for “sustaining capex.”
Sustaining capex refers only to capital expenditures necessary to maintain capacity at existing levels.
Sustaining capital expenditures (“capex”) refers only to replacement capital expenditures necessary to maintain existing capacity, the same capacity that is reflected in the revenue line of the pro forma cashflow statement. It effectively is the cashflow equivalent of amortization which, as a non-cash item, is removed when preparing a pro forma cashflow statement. If there is a cash recovery from items being replaced, such amounts should, if material, be netted off the outlays.
Given that pro forma cashflow statements usually show net cashflow after tax, sustaining capex similarly is shown after allowing for the tax saving generated by investing in replacement assets. The annual tax saving is equal to the undepreciated capital cost of the item multiplied by the capital cost allowance rate multiplied by the tax rate. The net tax saving is usually about 5% to 10% of the cost of the item (the saving will be higher where the government allows an accelerated annual capital cost allowance for tax).
Sustaining capex does not refer to the investment in new assets that provide additional, or expanded, capacity. If such expansionary capex is expected, it could alter the valuation method from a capitalized cashflow method to a discounted cashflow method, which takes more account of growth.
Contact MVI to discuss capital expenditures and whether these are sustaining (replacement) or expansionary expenditures.