Net Investment

Net Return
 Net Investment – The strategic amount of capital needed:
the initial cost of the project
A. Costs or Cash Outflows
1. Non Current Asset Requirements
a. Purchase price of the asset( net of cash
discount) P XXX
b. Incidental Costs – freight, insurance,
handling , & installation cost etc. XXX

2. Working Capital Requirements XXX

3. Market Value of idle asset utilized, XXX XXX

B. Benefits Outflows or cash inflow

1. Trade in Value of Old Asset XXX
( In case of replacement)
2. Proceeds from sale of old asset to be disposed P XXX
Tax on gain on sale ( tax rate x gain on
sale) (XXX)
Tax shield on loss on sale ( tax rate x gain
on sale) XXX XXX
3. Avoidable Cost of immediate repairs on old asset
replaced, net of tax XXX
NET INVESTMENT XXX
 Sample Problem:
 The World Trade Center Company plans to acquire a new
equipment costing Php 1,200,000 to replace the equipment
that is being used. The terms of the acquisition are 3/30.
n/90. Freight Charge on the new equipment are estimated at
23,000 and it will cost php 14,000 to install. Special
attachment to be used with this unit will be needed and
will cost Php 36,000 . If the new equipment is acquired,
operations will be expanded and this will require
additional working capital of 250,000. The old equipment
had an amortized cost of Php 300,000 and will be sold for
Php for 180,000. If the new equipment is not purchase, the
old equipment must be overhauled at a cost of 90,000. This
cost is deductible for tax purposes in the year incurred.
Tax rate is 35%.
 Solution
           
A. Costs or Cash Outflows        
  Purchase Price ( 1.2 million X 97 %)   1,164,000.00  
  Freight Charge     23,000.00  
  Installation Cost     14,000.00  
  Special Attachment     36,000.00  
  Additional Working Capital     250,000.00 1,487,000.00
           
B. Benefits or Cash inflow        
  Proceeds from Sale of Old Asset (180,000.00)    

Tax Savings from Loss of sale of

  old assets (120,000 X 35%)   (42,000.00)    
  Avoidable Repairs   (90,000.00) (312,000.00)  

Tax to be paid on avoided Repairs

  ( 90,000 X 35%)     31,500.00 (280,500.00)
           
  Net Cost of Investment       1,206,500.00
           
 The Purchase Discount is deducted Automatically Regardless of whether it is taken or
not
 Cash Inflow are deducted. Reduction in tax payments ( ie. Tax savings) and cost of
avoidable repairs are savings and are considered inflow.
 The loss from sale of old asset amounting to 120,000 ( ie. 180,000 – 300,000) is not
included in the computation. If there is a loss, net income decreases, and tax paid
decreases. The decrease in tax payment is a saving, an inflow. Hence, a deduction from
the cost of investment.
 The new asset is acquired, the cost of repairing the old asset is avoided. It is a saving
and inflow ( ie. 90,000). However, if the repairs are avoided. The net income increases
resulting to higher amount of tax paid amounting to 1,500 (ie. 90,000 x 35%).
Eventually, the net effect of the avoided repairs is 58,500 ( ie. 90,000 -31,500)
 The additional working capital is an outflow at the date of investment which shall be
recovered and treated as an inflow on the date the investment is terminated.
Net Cash Return from the Project
The net cash return corresponds to the inflows of cash from the
project as compared to the outflows that are needed to fund the
project.
An example would be:
Cash inflow from the project for one year
Less: Cash outflow for operations costs
Net cash inflow before payment of taxes
Less: Taxes [Tax rate (Net cash inflow – Depreciation)]
Net cash inflow after taxes for the year
The net cash return analysis takes into account the effect of
taxes in decision making. Non-cash expenses like depreciation
are added back to reflect the real cash outflow. Depreciation
is a non-cash expense since it is a mere estimate of a fixed
assets’ life expectancy, apportioned over its estimated life.
Hence, it must not be included in the computation of cash
flows.
Factors to Consider in
Evaluating Capital Expenditure
Sample Problem

 The Paniqui Corporation is planning to add a new product line to its business.
The new product will require a new equipment costing Php. 2,400,000 w/
five year life, no salvage value. The following Estimates are made available

 Annual Sales Php 12,000,000

 SD & A 2,100,000
 Materials 4,400,000
 Income Tax rate 40 %
 Labor 2,200,000
 Factory Overhead 1,300,000
(Excluding Depreciation on new equip.)
Solution

1 Cash Inflow Sales 12,000,000.00

2 Cash Outflow Less: Materials (4,400,000.00)
Labor (2,200,000.00)
Factory Overhead (1,300,000.00)
Selling and Admin
(2,100,000.00)
Expenses
Depreciation Expense (480,000.00) (10,480,000.00)

3 Net Cash Inflow Profit Before Expense 1,520,000.00

Before Payment
4 Tax Less: Income Tax ( 40 %) (608,000.00)
Profit 912,000.00
5 Depreciation Add Back:
Depreciation 480,000.00

NET CASH INFLOW 1,392,000.00

 Alternative Solution
After Tax Operating Cash Flows ( 2,000,000 x 60 %) 1,200,000.00
Tax Savings from depreciation ( 480,000 x 40 % ) 192,000.00
Net Cash Inflow From Operations 1,392,000.00

The Depreciation expense is relevant in computing the net income

but is irrelevant in determining net cash inflows. What is relevant
in net cash inflows is the tax savings from depreciation.