Capitalizing vs Expenditure therefore, increase, please

thisisbrianly

In Schwesernotes stated that: "Capitalizing an expenditure will initially results in higher return on assets (ROA) and higher return on equity (ROE)". Any one can prove it for me, please?

I think Capitalizing make higher return but increase asset or equity also, therefore, I am not sure such ratios up or down relatively expensing!!! May it give more condition like ROA is more or less than 1 to be more clear???

Thank for any help!

KungFuPanda

It is because of this inequality:
Numerator / Denominator <= (Numerator+k) / (Denominator+k)
For any non-negative k and numerator <= Denominator.

Although, I think there should be a tax effect too. $100 not expens'd means $30 of tax. Then the numerator and denominator are not increasing by the same amount.

mkytz15

davey is correct. Just think expensing= I take the hit now, so NI is lower, but if I'm capitalizing then I'm not taking the hit to expense, so NI is higher.

jcole21

Thank for all help. But I have a issue.

Image a hypothetical company with some figures:

NI (before below expenditure) = $ 7,000
Expenditure = $ 1000
Asset = $ 5,000
Tax = 40%

So,
If Capitalize, ROA = $ 7,000/ ($ 5,000+$ 1000)= 117%
If Expensing, ROA = ($ 7,000-($1000x60%))/$5,000= 128% greater than 117% (in frist year)???

Am I misunderstand in somewhere?

Valores

Giakhanh39,
From your example, only issue I see is if a company can produce $7000 NI from $5000 Assets, that is awesome!!! It could be possible if it is a service oriented company with less assets, but then expenses have to be much higher for salaries, overhead etc. So, in my opinion, this hypothetical scenario is not possible....

More realistically, companies have much much higher assets than NI.

SJ



Edited 2 time(s). Last edit at Friday, July 1, 2011 at 12:06PM by stockjaguar.