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CFA Level I · CFA Level I Exam · Financial Statement Forecasting in Equity Valuation

An analyst forecasts revenue growth for a manufacturer that is operating near full capacity. Which approach to forecasting capital expenditures is most appropriate?

Capital expenditures should be linked to the capacity needed to support forecast sales growth. A firm near full capacity must add net fixed assets to grow, so flat capex or capex equal to depreciation would understate investment and overstate free cash flow.

  1. AHold capital expenditures flat at the prior-year level
  2. BLink capital expenditures to the capacity added to support forecast sales growthCorrect
  3. CSet capital expenditures equal to depreciation expense

Explanation

A firm near full capacity needs new plant to support higher sales, so capex should be tied to the capacity required for forecast growth. Holding capex flat or setting it equal to depreciation implies no net capacity expansion, which is inconsistent with growth.

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