There is more than one definition of capital recovery in finance. When someone makes an investment on a company or an asset, he or she gets a negative return until the whole amount is returned. The RIO (Return on Initial Investment) made in such cases is called capital recovery.
There can be other definitions too. For example, capital recovery occurs when a company sells its machinery and recollects the money invested in them. In broad terms, capital recovery is the money that is the investment or money gained back from a project. Capital recovery is applicable to the asset's life span and the recovery period of the repayment.
Capital Recovery plays an important role while a company decides to buy new equipment. If the payments generated is higher than the purchase value of the equipment, if would be profitable for the company. For example, if you buy a printing press for INR 200,000 and expect INR 80,000 each year from it, you'll exceed the value in about 2.5 years. So, it would make sense to buy the equipment.
Note − Capital recovery can be used to decide whether a particular project would be profitable or not.
Once you decide to sell your assets, you might need to know the exact price of the equipment and fixed assets of your company. Here, capital recovery calculations play a vital role because you must know the price of the asset and by when you can recoup the price of it.
Companies that recollect the loans, such as business and equipment loans, represent themselves as capital recovery companies. Their major goal is to recover the loans and offer this to the lender who originally funded the loan. Debt collection is often done using the capital recovery formula.
Note − The capital recovery method is used in liquidation and debt collection.
Present Value = Annuity × Present Value of an Annuity Factor
PV = A × PVFA n.i ------ (1)
Where PVFA n.i represents the value factor of an annuity of INR 1 for n periods and i rate of interest.
The reciprocal of Present Value Factor is called Capital Recovery Factor and is given by,
A = p (1/PVFA n.i) ----- (2)
Now, the Present Value of Annuity can be written as,
P = A (1/i - 1/ i(1+i)n) ----- (3)
From equations (2) and (3), we get,
A = p × CRFn.i = p × (i (1+i)n / i (1+i)n -1
= (1/ (1/i - 1/i(1- i)n)
Which gives the capital recovery.
Note − To calculate the capital recovery, we use the formula of the Present Value of Annuity.