Definition: Net capital spending represents the difference between CapEx and depreciation and it is relative to the company’s growth.
What Does Net Capital Spending Mean?
What is the definition of net capital spending? NCS pertains to a company’s fixed assets, such as property, plant, and equipment, and it is the difference between the expenditure that the company makes in fixed assets and the depreciation of these assets.
Usually, firms that grow fast incur higher NCS than the low-growth firms. Because capital assets tend to lose their value during their useful life, financial analysts use the straight-line depreciation method to calculate the depreciation of the asset, assuming an equal amount over the course of the useful life (usually 20% of the initial value).
Let’s look at an example.
Example
Steven is a financial analyst at a boutique investment bank. He maintains a portfolio of clients with different needs for capital; however, over the past two weeks, he is dealing with Company ABC, a retailer that has recently purchased a new building. Steven wants to calculate the company’s NCS. Hence, he creates an Excel spreadsheet, as follows:
The company purchases the new building in Year 0 for $588,000; therefore, using the straight-line depreciation method, the depreciation over the course of the building’s useful life is $588,000 / 5 years = $117,600.
Steven subtracts the depreciation expense from the firm’s initial investment to find the book value: $588,000 – $117,600 = $470,400.
Then, he assumes that the market value of the firm in Year 4 (after 5 years) will be 15% lower, i.e. $588,000 x (1-15%) = $499,800.
From the initial investment, he subtracts the book value to find the profit on the investment: $588,00 – $470,400 = $117,600.
Then, he calculates the tax effect 35% of the initial investment: $588,000 x 35% = $205,800.
Hence, the net salvage value is market value – tax effect = $499,800 – $205,800 = $294,000.
The net capital spending is the total of the initial investment and the net salvage value minus depreciation: $588,000 + $294,000 – $117,600 = $764,400.
Summary Definition
Define Net Capital Spending: NCS means the amount of money spent on capital assets less depreciation.
