Corporate and Project Finance Modeling

Chapter 30Relationship of Growth, Capital Expenditures, Depreciation, and Return on Investment

If you could come up with formulas for normalized depreciation expense, capital expenditures, and deferred tax in the same sort of way that the stable working capital formula was derived in Chapter 29, computing normalized cash flow would be a straightforward process. You could then make a routine adjustment in the valuation section of your corporate models through adding normalized calculations for working capital, capital expenditures, and deferred taxes in the terminal free cash flow calculation. Similar types of adjustments could be made in using these types of formulas for stable ratios to compute implicit valuation multiples and in evaluating the value driver formula. Unfortunately, while the approach of applying a formula can be used for working capital changes, finding easy formulas to apply for capital expenditures and deferred taxes is more complex. The difficulty arises because of the manner in which changes in growth influence prospective levels of depreciation and because capital expenditures have a lifetime that is more than one year.

Because a simple one-line formula for normalized capital expenditure cannot be developed, the ultimate objective of this chapter is to come up with an easy-to-apply user-defined function for the ratio of capital expenditures to depreciation expense. With such a function that you can pop into any corporate model from information that is readily ...