Shareholder Return on Investment
Appreciation in value / dividends
There are two ways that a shareholder can receive a return on investment. One is the appreciation in value of the shares of the company (based on the future prospects of the company). The other is a cash payment (dividend) paid by the company to the shareholders. Many companies do not pay dividends to common shareholders, especially growing companies with lots of investment opportunities. We will discuss the methodology for determining the value of stocks later in the course.
Depreciation
DEPRECIATION in the Income Statement is a charge against income based on an estimate of the percentage of the original cost for fixed assets that has been used up in the production process during the period covered by the Income Statement.
For example, suppose that a piece of equipment is purchased for $500,000. For tax purposes, most governments do not allow companies to charge the entire $500,000 as a business expense at the time of purchase. Instead, they require the purchase to be "capitalized," which means it is carried on the books as an asset.
However, equipment has a finite useful life to the company, so governments allow a portion of the equipment purchase price to be deducted from operating expenses each year of its useful life. Typically, governments will provide depreciation schedules that classify each type of equipment and dictate its estimated useful life.
Straight-line depreciation
In our example, the piece of equipment may have an estimated useful life of five years and, therefore, will have no value at the end of the five years. Using a straight-line depreciation method, the annual amount that the company may deduct is ($500,000 - $0) / 5 yrs. = $100,000. There are several different depreciation methods and any accounting text can provide a more detailed discussion of their calculations and uses.
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