What is Net Investment?
How Does Net Investment Work?
The formula for net investment is:
In order to calculate the net investment of a company, you must first know the amount of capital expenditures and non-cash depreciation they have.
Capital expenditures include the calculated worth of all assets (i.e. property, software, equipment, etc.) and the amount of additional expenses being invested into those assets (i.e. maintenance, repair, upkeep, installation, etc.).
Capital assets lose value over their useful life. Asset depreciation can be calculated using two contrasting methods: the straight-line method or declining method. The straight-line method assumes an asset depreciates by an equal amount of its original value for each year it is used. The declining method assumes the asset depreciates more in the earlier years of its use.
At the end of the asset's useful life, the amount the asset is sold for represents its salvage value. Non-cash depreciation of an asset is represented as its salvage value minus any taxes the company paid on the asset throughout its useful life.
Let's assume that Company XYZ buys a new widget machine for $500,000 and pays someone $10,000 to install the machine in the factory. The company also expects to receive $75,000 from the sale of its old widget machine. Company XYZ is taxed at a rate of 30%.
Using the formula above, Company XYZ's net investment is:
Net Investment = ($500,000 + $10,000) – [$75,000 - (.30)*($75,000)] = $412,500
Why Does Net Investment Matter?
Because it is necessary to invest in capital assets that depreciate over time, companies may use the net investment formula to keep track of the assets that need to be replaced.
Comparing the net investment of companies to revenue will differ between businesses and industries depending on how capital intensive a company or industry is. Capital-intensive companies will typically have higher net investments than companies using fewer assets.
Comparisons of net investments are generally most meaningful among companies within the same industry. The definition of a 'high' or 'low' net investment should be made within this context.