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  1. 008A company's D&A is Rs 80 crore and its capex Rs 200 crore. Revenue is Rs 1,600 crore and growing 10% a year, and fixed asset turnover is 2.0x. Estimate how much of the capex is growth capex and how much is maintenance capex.Working capital and cash riddlesHardEquity researchCorporate FP&A

    Try it first

    How much of the Rs 200 crore is maintenance capex?

    Show the worked solution

    Growth capex is about Rs 80 crore and maintenance capex about Rs 120 crore. Revenue grows by Rs 160 crore, and at a fixed asset turnover of 2.0x each rupee of new revenue needs 50 paise of new assets, so growth capex is Rs 80 crore. The rest, Rs 120 crore, replaces worn assets. That is Rs 40 crore more than D&A, because D&A records assets at the older prices paid for them.

    Why not just say maintenance capex equals D&A?

    Think of a taxi owner who bought a car eight years ago for Rs 6 lakh and has been setting aside Rs 75,000 a year as depreciation. When the car dies, the same model costs Rs 9 lakh, not Rs 6 lakh. D&A spreads the price paid for old assets, while maintenance capex pays today's price to replace them, so with any inflation the two drift apart. D&A is a reasonable floor for maintenance spending, not an estimate of it.

    How does fixed asset turnover split the capex?

    Fixed asset turnoverRevenue divided by net fixed assets. At 2.0x, each rupee of plant and equipment supports two rupees of yearly revenue. tells you how much plant each rupee of revenue needs. At 2.0x, the company's Rs 1,600 crore of revenue sits on about Rs 800 crore of net fixed assets. If the new revenue needs assets at the same ratio, the Rs 160 crore of growth needs Rs 80 crore of new capacity, and that is growth capex. Whatever is left of the Rs 200 crore went on keeping the existing Rs 1,600 crore of revenue alive.

    The relationship
    growth capex=ΔrevenueFAT=1602.0=80maintenance=200−80=120\text{growth capex} = \frac{\Delta \text{revenue}}{\text{FAT}} = \frac{160}{2.0} = 80 \qquad \text{maintenance} = 200 - 80 = 120
    Δ revenuenext year's extra revenue, 10% of 1,600
    FATfixed asset turnover, revenue over net fixed assets
    What it says in wordsNew capacity is the new revenue divided by how much revenue each rupee of assets supports; the rest of capex is upkeep.
    Capex of Rs 200 crore, split two waysRevenue 1,600 grows 10%New revenue = 160160 / turnover 2.0xGrowth capex = 80Capex 200 less growth 80Maintenance = 120All figures Rs crore80 maint.120 growthShortcut120 maint.80 growthTurnover method80D&AD&A level+40Shortcut assumes maintenance = D&A; the turnover method does not
    Treating D&A as maintenance splits the Rs 200 crore into 80 of maintenance and 120 of growth. The turnover method gives the opposite split, 120 of maintenance and 80 of growth, so maintenance runs Rs 40 crore above D&A.

    Is Rs 120 crore believable, and what is the catch?

    Check it against inflation. If the average asset was bought about eight years ago and equipment prices rose 5% a year, replacing it costs 1.05 to the power 8, about 1.48 times its original price. Rs 80 crore of D&A at today's prices is about Rs 118 crore, close to the Rs 120 crore estimate, so the split hangs together. The catch is that turnover is measured on net book value, which is itself at old prices. New capacity bought at today's prices may need more than 50 paise per rupee of revenue, which would make growth capex larger and maintenance smaller. Give the estimate as a range, and say why it matters: free cash flow before growth spending is Rs 40 crore lower than the D&A shortcut suggests.

    Where candidates lose it

    The common loss is the shortcut: maintenance equals D&A, so growth capex is 200 less 80, which is 120. It gives exactly the reverse of the turnover answer and overstates how much cash the business could release if it stopped growing.

    The second loss is giving 120 and stopping. Say why D&A understates replacement cost, then name the weakness in your own method, the book-value turnover, before the interviewer does.

    What the interviewer asks next

    • If growth stopped tomorrow, how much free cash flow would the business release each year?
    • How would you estimate maintenance capex from five years of the company's own history?
    • Why might a company with ageing assets report rising margins while its true earnings power falls?