Net investment is the total capital expenditure minus depreciation of assets. Net investment gives an indication of how much the effective productive capacity of a firm is increasing. Net investment shows how much working capital is actually increasing.
Depreciation means a decline in value, for example, if a machine breaks down and is no longer useable.
The difference between net investment and gross investment explained
Suppose, in the first year of business, a firm invested £2 million on new machines. In this first year, the gross investment (£2m) would be the same as the net investment (£2m) – because there is no depreciation.
However, in the second year, let us imagine one machine worth £0.5m breaks down.
In the second year, if the firm spends an extra £1.3 million on buying new machines. Then in the second year:
- Gross investment = £1.3 million
- Depreciation = £0.5 million (the machine that broke down)
- Net investment = £0.8 million
At the end of the second year, the firm has machines with £2.8 million which are working.
Zero net investment
Suppose a factory burns down, causing a £400,000 loss. If a firm pays £400,000 to re-build the factory, then its gross capital expenditure is £400,000. However, the net investment is £0. The firm still has the same capacity. There is no increase in net capital stock.
Negative net investment
If a firm has depreciation of £5 million, but only spends £3 million on capital expenditure, then it is seeing negative net investment of £ -2million. The productive capacity of the firm will be declining which may affect its ability to produce goods in the future.
Factors affecting depreciation
Existing capital stock can depreciate due to
- Wear and tear
- Breaking down
- Expenditure on repair
- Technical obsolescence
Calculating net investment and depreciation
A firm may calculate depreciation by using an expected lifespan of capital. Suppose a firm invest £10 million in a train, which has an expected working life of 20 years. In this case, the depreciation would be £0.5 million for the next 20 years.
At the end of the first year, the net investment would be £10 million – £0.5 million = £9.5 million.
6 November 2019