Not including invetment cost in Profit analysis !?

Question

I was solving this case study where we had to comapre profitiblity between 2 scenarios :

1-Back integration (purchasing plant)

2-Keep on purchasing material from suppliers.

Since were purchasing a plant we have an additional investment cost (construction cost) of 750M$.However, The service life was not given and this investment was not included as a cost when calculating profits in the solution.

Any ideas ?

Answer 1

Hi,
strictly speaking, profits are the net earnings in a period as a result of doing business. In order for a company to do its business, it usually needs to invest upfront prior to conducting business, let's say before the first period of consideration, which is usually considered period 0. Sometimes companies amortize the investment costs over a number of periods and consider the amortisation a fixed cost. Most often investment costs are not included in the fixed costs. In such a case, I suggest splitting the financial branch of your structure into two segments (profits (t>=1) and investment (t=0)). That's a safe and MECE way. If in doubt, ask the interviewer which approach (s)he prefers.

Best of luck,
Daniel

Answer 2

Hi,

Ask if the investment is amortized:

If no - it will be the whole investment in year 0 and you should subtract it from profits
If yes - you can subtract the part of investment each year

Best!