Online Tutorial #5: How Do You Calculate A Company's Incremental Fixed Capital Needs?
Incremental investment in fixed capital is another important value driver in an analysis of shareholder value. This session focuses on where to find the data, how to calculate historical fixed capital trends and how to project future fixed capital needs. As with previous sessions, we will use Gateway, Inc. as of April 21, 2000, as a case study. Readers who want to calculate incremental fixed capital while reading this tutorial may wish to download the accompanying spreadsheet.
What Does "Incremental Fixed Capital" Mean?
To understand what we mean by "incremental fixed capital," let's break this phrase down into its component parts:
- Incremental . This means that we want to look at the additional cash a company annually invests in its long term operating assets.
- Fixed . This means we look at cash tied up in long term operating assets such as Plant, Property and Equipment (PP&E) and Capitalized Leases.
- Capital . This means that we want to calculate the amount of cash that a company
has to tie up annually in incremental fixed capital in order to run its business.
For industrial companies, then, "incremental fixed capital" equals the cash a company invests annually in long term operating assets .
We can calculate a company's annual investment in fixed capital by analyzing its Cash Flow Statement. To calculate a company's gross fixed capital investments, we sum the following items:
- Capital expenditures
- Capitalized software costs
- Other investment activities, net
- Acquisitions, net of cash acquired
However, before we finish, we need to deduct annual Depreciation and Amortization (found on the Cash Flow Statement in the "Cash Flow from Operating Activities" section). This is because we want to calculate cash invested over and above a company's annual depreciation. Intuitively, this makes sense because when capital expenditures equals depreciation, a company is roughly maintaining its long term physical assets. In other words, we consider only capital investments above and beyond depreciation as "incremental" investments.
Case Study: Gateway, Inc. as of April 21, 2000
The following table summarizes calculations for Gateway: