Return of Capital - Time Value of Money

Time Value of Money

Some people dismiss ROC (treating it as income) with the argument that the full cash is received and reinvested (by the business or by the shareholder receiving it). It thereby generates more income and compounds. Therefore ROC is not a "real" expense.

There are several problems with this argument.

• No one is arguing that the income earned on the full cash flow reinvested is not additional real income.
• If the original asset purchase had not been made, its cash cost would have been invested and earning returns in that same way.
• If you consider that depreciation is an allocation of the original cost of the asset, then you must agree that time value of money considerations make the original cost HIGHER than the sum of the subsequent ROC expenses not realized until many years in the future.
• If you consider that depreciation measures the amount of cash that must be retained in order to finance the eventual replacement asset, then you must agree that the cost of that replacement will have increased in cost in the interim by inflation for that asset. Inflation is the basis for the time-value-of-money.