5.18 Sustaining capital expenditures
Capital assets, also referred to as fixed assets or property, plant, and equipment, are probably one of the biggest items that a business may spend cash on.
Capital expenditures (“capex”) can take two forms:
- Expansion capital, where new property, plant, or equipment is acquired to help the business grow;
- Sustaining capital, where new property, plant, or equipment is acquired to replace old or outmoded assets without increasing the output capacity of the business. Sustaining capital expenditures should not be confused with repairs and maintenance, where cash is spent to simply repair existing equipment.
Capital expenditures to maintain the business at existing capacity should be differentiated from expenditures to increase capacity.
In a cashflow based valuation, it is important to distinguish between expansion capital and sustaining capital. If there is only sustaining capex, the most appropriate valuation method is likely the capitalized cashflow method, where the non-discretionary sustaining capex is deducted from other cashflows to demonstrate what cash the business generates in its current state (before providing for financing commitments).
However, if there is likely to be significant sums spent on assets to expand the capacity of the business, there will be an expectation of significant growth in revenues as well. In this case, a discounted cashflow method will be the most suitable valuation method.
Contact MVI to discuss your plans for capital expenditures and how these may impact the valuation of your business.