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Once more, here is a summary of the requirements and process involved in order for these equations to give meaningful results.

• The Net Income for Year 1 is assumed or known.

• Historical values for the Investment Rate (IR) and Net Income Return on Capital Employed (NiROCE) are assumed to be reasonable estimates for future years or arbitrary numbers based on some rationale.

• The underlying assets that generated Year 1's Net Income will continue to do so for the estimating horizon.

• Net Investments (NetInvest) made during Year 1 don't provide an immediate return but take time and this incremental Net Income is generated in Year 2.

• Year 2's Net Income is the sum of the repeating Year 1's Net Income and the Incremental Net Income in Year 2.

• Like Year 1's Net Income, the incremental assets that generated Year 2's Incremental Net Income will also produce a stream of equal Net Incomes during subsequent years.

• The Cash Flow estimates for each year don't suffer this complication and are relatively straightforward.

The operative equations are:

[2-8]NetInvestn = (NIn)(IRn)

[2-12]NI₍n _{+ 1)} = NIn + (NetInvestn)(NiROCE₍n _{+ 1)})

[2-14]NI₍n _{+ 1)} = (NIn)[1 + (IRn)(NiROCE₍n _{+ 1)})]

[2-16]CFaIAn = NIn − NetInvestn ± NetIntn ± ΔWCn

[2-18]CFaIAn = (NIn)(1 − IRn) ± NetIntn ± ΔWCn

These equations can be also classified according to the variables used and in the case study at the end of this chapter are referred to as such.

Net Investment (NetInvest) Model or Form

Equations [2-12] and [2-16] constitute the Net Investment Model.

[2-12] NI₍n _{+ 1)} = NIn + (NetInvestn)(NiROCE₍n _{+ 1)})

[2-16] CFaIAn = NIn − NetInvestn ± NetIntn ± ΔWCn

Investment Rate (IR) Model or Form

Equations [2-14] and [2-18] constitute the Investment Rate Model.

[2-14]NI₍n _{+ 1)} = (NIn) [1 + (IRn)(NiROCE₍n _{+ 1)})]

[2-18]CFaIAn = (NIn)(1 − IRn) ± NetIntn ± ΔWCn

Year 1:

Recalling Equation [2-8],

[2-8]NetInvestn = (NIn)(IRn)

if NI₁ is the Net Income for Year 1 in a company that has a Investment Rate IR₁, then by Equation [2-8] the Net Investment in Year 1 is:

[2-19]NetInvest₁ = (NI₁)(IR₁)

The Cash Flow in Year 1 is given by the use of Equation [2-16]:

[2-16]CFaIAn = NIn − NetInvestn ± NetIntn ± ΔWCn

Substituting subscripts in Equation [2-16] the Cash Flow after Investing Activities, CFaIA for Year 1 in terms of Net Income and Net Investments is:

[2-20]CFaIA₁ = NI₁ − NetInvest₁ ± NetInt₁ ± ΔWC₁

Or by using Equation [2-18] and making suitable substitutes for n the CFaIA in Year 1 is calculated knowing the Net Income and the Investment Rate IR₁45

[2-21]CFaIA₁ = (NI₁)(1 − IR₁) ± NetInt₁ ± ΔWC₁

Year 2:

Year 2's Net Income can be calculated with either Equation [2-12] or [2-14] after making suitable adjustments to the subscripts.46

[2-22]NI₂ = NI₁ ± (NetInvest₁)(NiROCE₂)

Or:

[2-23]NI₂ = (NI₁)[1 + (IR₁)(NiROCE₂)]

In Year 2 investments are made at a rate IR₂, therefore the Net Investment in Year 2, NetInvest₂, is:

[2-24]NetInvest₂ = NI₂(IR₂)

And following the same logic that resulted in Equations [2-20] and [2-21] the CFaIA₂ for Year 2 is calculated by:

[2-25]CFaIA₂ = NI₂ − NetInvest₂ ± NetInt₂ ± ΔWC₂

or

[2-26]CFaIA₂ = (NI₂)(1 − IR₂) ± NetInt₂ ± ΔWC₂

Year 3:

Repeating the above process for Year 3 produces the Net Income in Year 3 in terms of Net Investments and Net Income Return on Capital Employed:

[2-27]NI₃ = NI₂ + (NetInvest₂)(NiROCE₃)

or Year 3 Net Income in terms of the Investment Rate and Net Income Return on Capital Employed:

[2-28]NI₃ = (NI₂)[1 + (IR₂)(NiROCE₃)]

The Year 3 CFaIA equations are:

[2-29]CFaIA₃ = NI₃ − NetInvest₃ ± NetInt₃ ± ΔWC₃

[2-30]CFaIA₃ = (NI₃)(1 − IR₃) ± NetInt₃ ± ΔWC₃

and so on.