In a simple model, how are depreciation and capital expenditures typically projected?

• A. They are projected as a fixed dollar amount each year
• B. They are projected as a percentage of revenue using the prior period PP&E balance
• C. Depreciation is projected as a percentage of gross profit, and CapEx is ignored
• D. They are projected as a percentage of total assets

Answer: (B)

In a simple model, depreciation and capital expenditures are forecast using clear drivers tied to the size and age of the business. Depreciation is estimated from the prior period PP&E balance multiplied by a depreciation rate, which captures that a larger, older asset base yields a larger depreciation charge and that depreciation moves with changes in the asset base. CapEx is typically projected as a percentage of revenue, reflecting that investment needs scale with the company’s sales and growth. Using the prior period PP&E balance to anchor depreciation keeps the expense linked to the existing asset base, while tying CapEx to revenue aligns investment with the company’s scale. This approach provides a straightforward, internally consistent way to project these cash flow components. Other methods either ignore how CapEx or depreciation respond to business size and asset aging or apply inappropriate bases, making them less representative of how companies actually invest and wear out assets.