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Net Investment and Depreciation illustration

# Net Investment and Depreciation illustration - Ã 5 = 2000...

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Net Investment and Depreciation illustration: As an illustration, let a company that produces goods possess a total stock of capital goods worth \$10,000. These capital goods such as machinery, tools etc. may have an average life span of 5 years. Therefore after 5 years the entire capital stock will be exhausted and no further productive activity will be possible. In order to replace the present stock after 5 years some amount of current income has to be set aside. Such an allowance is called depreciation charge or alternatively capital consumption or replacement charge . In the above example, the firm has to set aside 1/5 or 20 percent of the value of the stock every year. Hence the firm’s depreciation charges will be \$2000 per year (10,000

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Unformatted text preview: Ã· 5 = 2000). If the annual investment activity of the firm is \$3000 then it can add to the stock as well. In this case \$3000 is the gross investment . Out of this amount \$2000 are required for depreciation purposes; the remainder \$1000 is the firmâ€™s net investment. We can conclude that the firmâ€™s net investment or capital formation activity will be positive and its stock of capital will increase when its gross investment exceeds depreciation requirement. If gross investment falls short of the depreciation allowance then net investment will be negative. GI - D = NE 3000 - 2000 = 1000 Positive GI -D = NE 2000 - 2000 = 0 Nil GI -D = NE 1500 -2000 = - 500 Negative...
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Net Investment and Depreciation illustration - Ã 5 = 2000...

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