Chapter 10: Incremental Fixed Asset Investments

There's a huge difference in the business that grows and requires a lot of capital to do so, and the business that grows, and doesn't require capital.

Warren Buffet

There are two types of capital investments that have to be made if any company has to grow:

  • Incremental Fixed Asset Investments
  • Incremental Net Working Capital Investments

Incremental Fixed Assets

For all the growth one requires in a company, one has to make investments in fixed assets. If Toyota has to grow it has to build plants; for Walmart or Avenue Supermart to grow, it has to add stores and warehouses. If Nestle has to grow, it has to acquire brands and invest in innovation and product development.

This is the sixth step in the process of valuation - estimating gross capital expenditure that includes investments in fixed assets, intangibles and acquisitions less depreciation &amortization expense. As mentioned in the previous chapter, we need to deduct depreciation & amortization from gross capital expenditure to arrive at the correct cash flow, as depreciation &amortization is already deducted in arriving at the operating profit.

This is the Operating Cash Outflow for the company. This investment can either be stated in absolute numbers or one may use a percentage of incremental fixed assets investments to incremental sales to estimate this.

Incremental Fixed Assets Rate (%) = Incremental Fixed Assets Investment
Incremental Sales

If a company has to grow it has to make Investments in Fixed Assets. Fixed Asset Investments include Acquisitions.

The Incremental Fixed Assets Investment is the Net Investments in Fixed Assets including intangibles, acquisitions etc., (Net Block of Fixed Assets). The estimates of capital expenditures can be taken from company releases, annual reports, press releases, etc., and be stated in net fixed asset investments as cash outflow into the valuation. However, if such information is not available, then one can check the latest financials and use the Net Fixed Asset to Sales Ratio as the Incremental Fixed Asset Investment Rate and project the Incremental Fixed Asset Investments.

Net Fixed Assets

A significant portion of the value of a company is in the terminal value (Capitalization of the Free Cash Flows in the Target Year of the Forecast Period to perpetuity). The target Fixed Assets Investment Rate in the last year of the forecast period) is also any important driver for this value therefore, one needs to determine the Target Fixed Assets Investment Rate carefully.

The example of Computation of Incremental Fixed Asset Investment for Black Bay Pizza is presented in the subsequent Chapter 11 of Incremental Working Capital Investments.