Final answer:
In the capitalized cash flow approach, sustaining capital reinvestment is deducted from projected cash flows before capitalizing them, after factoring in the present value of the tax shield benefits.
Step-by-step explanation:
The capitalized cash flow (CCF) approach is a method used in business valuation. It involves adjusting the projected cash flows of a business to account for the reinvestment of profits for sustaining the company's growth. When calculating the value of a business using the CCF approach, sustaining capital reinvestment is a critical component that needs to be considered along with present discounted values and tax shields. To answer the question, 'In the capitalized cash flow approach: a) Sustaining capital reinvestment is added back. b) Sustaining capital reinvestment is deducted. c) Sustaining capital reinvestment is multiplied. d) Sustaining capital reinvestment is ignored', the correct option is b) Sustaining capital reinvestment is deducted.
When a company reinvests in its operations, such as purchasing new equipment or upgrading facilities, these costs are known as sustaining capital reinvestment. In the CCF approach, these reinvestments are generally subtracted from the projected cash flows before capitalization because they represent cash outflows necessary to maintain the company's current operational level and are not available to investors. However, the net investment expense is considered, which means that the present value of the tax benefits from the capital cost allowance, or tax shield, is factored into the calculation and can lower the ultimate deduction from the cash flow.