Estimating Reinvestments for a company in DCF analysis: Capex, R&D, and Working Capital

Definition of Capex: expenses designed generate benefits over many years

1.     Firms seldom have smooth capital expenditure streams: They can go through periods when capital expenditures are very high, followed by periods of relatively light expenditures. Consequently, when estimating the capital expenditures to use for forecasting future cash flows, we should look at capital expenditures over time and normalize them by taking an average, or we should look at industry norms.

2.     R&D expenses are really Capex. R&D expenses are treated as Capex, and the research asset that is created as a consequence needs to be amortized, with the amortization showing up as part of the depreciation.

3.     When estimating Capex, we should not distinguish between internal investments (which are usually categorized as capex in cash flow statements) and external investments (which are acquisitions). The capital expenditures of a firm therefore need to include acquisitions, whether they are funded with stock or cash.

4.     The second component of reinvestment is the cash that needs to be set aside for working capital needs.