Consider a firm in an industry in which technology improvements are constantly lowering its cost of physical capacity. On average, the cost to acquire a unit of physical capacity drops by about 15% per year and is expected to continue to do so for the foreseeable future. Fixed assets are depreciated on a straight-line basis over five years and, if not for the dropping cost of capacity, would represent a reasonable estimate of the amount of capital investment necessary to maintain capacity at the existing level.
Construct formulas that could be used in a free cash flow forecast model to determine the amount of depreciation and capital expenditures in a given year. Assume that sales have already been forecasted and are represented by SALES.