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Why do we deduct Capex from the FCFF, FCFE calculations ?



Capital Expenditure (Capex) is one of the mandatory expense that a firm has to incur in order to sustain its business, HOW?


Well, Capex can be grouped into 2 types


1) Growth Capex

2) Maintenance Capex


Growth Capex are the reinvestments made by the firm into its business for expansion. This could be increasing production capacities, purchasing assets etc. that can help the firm grow organically in the long run. Such type of expenses are discretionary in nature.


That is, it is based upon the management's decisions considering multiple variables like availability of funding, room for adding more leverage to firm's books etc. It can be pushed back if the conditions don't seem right (hence discretionary expense)


Maintenance Capex in turn is a mandatory expense that a firm has to incur. Putting it simply, your firm cannot produce inventory if your assembly line is broken or if the laptops are outdated etc. This would pose a threat to a firm's going concern (existence).


Investors (both debt and equity) have invested their money into a firm so that the firm can deliver the product or the service it has established itself for.


Hence such mandatory reinvestments have to be deducted when assessing the residual cashflows to firm (FCFF) and equity investors (FCFE)


Thanks,

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