Capital Investments

10 Key excerpts on "Capital Investments"

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  Corporate Finance

  Economic Foundations and Financial Modeling

  • Michelle R. Clayman, Martin S. Fridson, George H. Troughton, Michelle R. Clayman, Martin S. Fridson, George H. Troughton(Authors)
  • 2022(Publication Date)
  • Wiley

    (Publisher)

  Capital Investments describe a company’s future prospects better than its working capital or capital structure, which are often similar for companies, and provide insight into the quality of management’s decisions and how the company is creating value for stakeholders. 109 While the focus of this coverage is on Capital Investments, it is important to note that companies also make other investments in increased working capital, information technology (IT), and/or human resources projects that might not be capitalized and therefore affect near- term operating profit, but that are made for similar longer-term benefit as Capital Investments. 2. TYPES OF Capital Investments The types of Capital Investments made by companies vary considerably and often span the full spectrum of risk and return. Some are less risky and fairly easy to evaluate, such as the replacement of depreciated equipment, while others, such as the development of a new product or an acquisition of another company, are riskier and far more complex. Capital Investments are undertaken for two primary purposes—to maintain the existing business and to grow it—and can generally be classified into four types of projects. The first two types, 1. going concern (or maintenance) projects and 2. regulatory/compliance projects, ensure business-as-usual continuity while the latter two investment types, 3. expansion projects and 4. other projects, are made to expand the business in some strategic manner. Each of these is highlighted in Exhibit 1 with a brief explanation and examples. EXHIBIT 1: Types of Capital Projects Business Maintenance Business Growth 1. Going concern Projects necessary to continue current operations and maintain existing size of the business or to improve business efficiencies Example: machine replacement, infrastructure improve- ment 3.

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  Accounting and Finance

  • Michael J. Jones(Author)
  • 2014(Publication Date)
  • Wiley

    (Publisher)

  Nature of Capital Investment Capital investment is essential for the long-term survival of a business. Existing property, plant and equipment, for example, wears out and needs replacing. The capital investment decision operationalises the strategic, long-term plans of a business. As Figure 17.1 shows, long-term capital expenditure decisions can be distinguished from short-term decisions by their time span, topic, nature and level of expenditure, by the external factors taken into account and by the techniques used. Chapter Summary • Capital investment decisions are long-term, strategic decisions, such as building a new factory. • Capital investment decisions involve initial cash outflows and then subsequent cash inflows. • Many assumptions underpin these cash inflows and outflows. • There are five main capital investment techniques. Two (payback and accounting rate of return) do not take into account the time value of money. Three do (net present value, profit- ability index and internal rate of return). • Payback is the simplest method. It measures how long it takes for a company to recover its initial investment. • The accounting rate of return uses profit not cash flow and measures the annual profit over the initial capital investment. • The profitability index is similar to Net Present Value (NPV). It compares the total NPV cash flows with the initial investment. • Net present value discounts estimated future cash flows back to today’s values. • Internal rate of return establishes the discount rate at which the project breaks even. • Sensitivity analysis is often used to model future possible alternative situations. A C C O U N T I N G A N D F I N A N C E 493 Capital budgeting is a term which is often used for capital investment decisions. As Real-World View 17.1 shows, there is a distinct difference between capital and operating expenditures. Characteristic Short-Term Long-Term 1. Time Span Maximum 1 to 2 years, mostly present situation Upwards from 2 years 2.

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  Return on Investment Manual

  Tools and Applications for Managing Financial Results

  • Robert Rachlin(Author)
  • 2019(Publication Date)
  • Routledge

    (Publisher)

  Many Capital Investments tie in with the future plans of the company. These plans anticipate growth, recovery of resources, and directions that a company must take to succeed in a given economic environment. Sometimes, a shift of emphasis is placed on the direction through certain investment opportunities. The ability to project the future becomes more and more difficult.

  In addition to the support of top management, other key elements go into the success or failure of a capital investment. They center on the ability of top management to time the capital investment in such a way that maximizes the benefits expected for the project. Timing is a vital ingredient to the success or failure of most Capital Investments. Not only is it important for the acquisition of machinery and equipment but also for investments in working capital. Knowing when to tighten up on accounts receivable and add inventory and what cash balances to maintain are all important questions that revolve around timing.

  Top management must also give clearly defined directions and make sure that the entire capital process is adequately coordinated throughout the company.

  The capital investment process involves investing in many different areas of the company. It may require investments in a functional activity of a company, such as to support the sales effort, production requirements, distribution, or administrative needs. There are usually no guidelines as to how much is spent on functional activities of the company. As long as funds can be made available, and justification can be supported, investments in these areas are usually made.

  Types of Asset Investments

  There are many different types of investments in assets. But such investments can be categorized into three major areas: physical assets, working capital, and research projects.

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  Basic Management Accounting for the Hospitality Industry

  • Michael Chibili(Author)
  • 2019(Publication Date)
  • Routledge

    (Publisher)

  Capital investment decisions 15.1 Types of capital budgeting decisions 15.2 Basic methods for making investment decisions 15.3 Simple and compound interest 15.4 Process of discounting 15.5 Understanding factor tables 15.6 Discounted cash flow (DCF) methods 15.7 Incidence of taxes on DCF analysis 15.8 Choosing between projects Businesses are created with the aim of existing forever. For this to become possible, the business must be able to earn profits over a period of years. In this case, short term gains might have to be sacrificed in the interest of long term goals. Decisions that involve the acquisition of equipment, land, buildings, and vehicles are examples of decisions that businesses will periodically have to make that have an influence on their cash flows. In the hospitality industry, the largest investments that are normally made will be about land or building acquisition. However these are not decisions that are made on a day-to-day basis. Whether the opportunity involves building a new hotel, modernizing an old one, or extending a hotel, money must be made available and spent on what might be called a ‘capital investment’ that is expenditure incurred now in order to produce a stream of benefits over a period of years which will, it is hoped, result in the firm being in a more favourable position. Capital investment decisions differ from operating decisions by reason of the nature of the expenditure and the length of time before the full effect of the decision is felt. Capital investment decisions may concern the following: · The acquisition or replacement of long-lived assets, such as buildings and equipment. · The investment of funds into another firm from which revenues will flow. 313 15 © Noordhoff Uitgevers bv · A special project which will affect the firm’s future earnings capacity. · The extension of the range of activities of the firm.

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  What Every Engineer Should Know about Accounting and Finance

  • Norman Henteleff, Jae K. Shim, Shim(Authors)
  • 1994(Publication Date)
  • CRC Press

    (Publisher)

  12 EVALUATING CAPITAL EXPENDITURE PROJECTS Capital expenditure decisions, commonly known as capital budgeting, is the process of making long-term planning decisions for alternative investment opportunities. There are many investment decisions that the company may have to make in order to grow. Examples of capital budgeting applications are numer-ous. When should old facilities be replaced? Which piece of equipment should be selected to perform a particular operation? Should equipment be leased or purchased? Which product line should be selected? Should the company have one big plant or several smaller ones? Should the firm embark on a new research and development program? WHAT ARE THE TYPES OF INVESTMENT PROJECTS? There are typically two types of long-term investment decisions: 1. Selection decisions in terms of obtaining new facilities or expanding existing ones: Examples include: a. Investments in property, plant, and equipment as well as other types of assets. b. Resource commitments in the form of new product development, market research, introduction of a computer, refunding of long-term debt, and so on. c. Mergers and acquisitions in the form of buying another company to add a new product line. 2. Replacement decisions in terms of replacing existing facilities with new ones. Examples include replacing an old machine with a high-tech machine. 183 184 Chapter 12 WHAT ARE THE FEATURES OF INVESTMENT PROJECTS? Long-term investments have three important features: 1. They typically involve a large amount of initial cash outlay which tends to have a long-term impact on the firm's future profitability. Therefore, this initial cash outlay needs to be justified on a cost-benefit basis. 2. There are expected recurring cash inflows (for example, increased rev-enues, savings in cash operating expenses, etc.) over the life of the investment project. This frequently requires considering the time value of money.

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  Introduction to Corporate Finance

  • Laurence Booth, Ian Rakita(Authors)
  • 2020(Publication Date)
  • Wiley

    (Publisher)

  The irrevocable and unique nature of real investments has its parallel in investments in intangible assets. The decision to bring out a new soft drink, for example, with the attendant new prod- uct development costs and marketing campaign, is also irrevocable. In this case, it is almost impossible to recover the investment costs of a failed new product launch. The importance of capex decisions lies in their ability to affect the risk of the firm. In some cases, the very survival of the firm depends on the success of a new product produced from prior capex decisions. Ford, for example, was saved from extinction in the 1980s when it brought out the then revolutionary Ford Taurus, which went on to become the most popular family car in North America. Capital budgeting refers to the process by which a firm makes capital expenditure decisions, as shown below. Identify investment alternatives → Evaluate these alternatives → Implement the chosen investment decisions → Monitor and evaluate the implemented decisions We will focus most of our discussion on the general framework that should be used to evaluate various investment alternatives, because the remaining decisions are firm‐specific and covered in managerial accounting (which develops the firm’s control and audit systems). First, we will briefly discuss some important factors in the investment process. One of the factors contributing to improved productivity is increased investment in machinery and equipment. Conversely, one could surmise that if a firm does not invest effectively, it will find itself at a competitive disadvantage, which in the extreme will affect its long‐term survival. In the short run, poor investment decisions will make a firm less attractive than those that have better prepared themselves for the future. This will show up in the mar- ket price of the firm’s debt and equity securities, which will decline, and will hence increase its cost of capital.

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  The AMA Handbook of Financial Risk Management

  • John Hampton(Author)
  • 2011(Publication Date)
  • AMACOM

    (Publisher)

  Substantial dollar amounts . These investments are generally made in large projects involving tens or even hundreds of millions of dollars. In terms of dollars alone, capital budgeting decisions are significant to even the largest corporations.

  • Long time periods . When financial securities are purchased, a decision that is made today can easily be reversed tomorrow. Stock bought on an exchange can be sold, reversing the transaction. This is not the case with the purchase of capital assets. The company is making a long-term decision that is not likely to be reversed in a short period of time.

  • Loss of liquidity . Money invested in capital assets is not readily available for other purposes. The loss of liquidity adds to the significance of capital budgeting activities.

  • Over- and undercapacity . If the budget is drawn carefully, it usually improves the timing and quality of asset acquisitions. If it is done poorly, it can cost the firm large sums of money because it leads to overcapacity or undercapacity, sometimes at the same time. The firm may have idle assets to produce a product that is not in demand, but also have a shortage of the machinery and facilities needed to produce a much-demanded, high-profit product.

  Motives for Investment

  A corporation evaluates capital budgeting proposals for several reasons, including:

  • High profits . Capital Investments offer the prospect of high risk and high return. One motive for investing is to earn a high profit.

  • Growth . By purchasing capital assets that offer potentially high returns, a corporation can accelerate its growth.

  • Diversification . Many companies operate in cyclical businesses. A company can reduce the risk of large losses in one area by acquiring other lines of business.

  Ranking of Proposals

  Once the capital budget is nearing completion and different projects have been identified, the firm must select the projects it will finance. Among the problems that arise are the following:

  • Mutually exclusive projects . If the firm accepts one project, it may rule out another. These are called mutually exclusive projects

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  Managerial Finance

  • Alan Parkinson(Author)
  • 2012(Publication Date)
  • Routledge

    (Publisher)

  The significance of the capital investment decision is thus clear. The reasons rationalizing the significance apply to longer term investment decisions in general although their degree of significance, and thus their degree of influence upon decision-making, will vary according to the particular type of decision and organizational activity being looked at. A common feature that all capital budgeting decisions have with shorter term investments is that managers are looking at making investments which will (hopefully!) produce returns. The distinction is that the longer term investment decision will produce returns over a number of future time periods rather than the current period returns which arise from other types of decisions.

  Capital investment decisions will generally be concerned with the planning for and management of activities such as:

  • the acquisition of fixed assets such as land and buildings, plant and equipment and vehicles (be it a first-time or replacement acquisition)
  • investment in a special project such as a marketing/advertising campaign or research and development
  • the expansion of current facilities, be they production or administrative or in relation to any other
  • entry into new product/service provision
  • investment in development of managers, such as yourself, through training and education.

  Such investment decisions are never easy Often, given the long-term nature of the decision consequences, the projected outcomes and associated returns are at best uncertain and at worst unpredictable and/ or intangible. Given this scenario it is understandable that many managers seek advice from all quarters as an aid to reducing the risk of making the wrong capital investment decisions. What they invariably seek is a framework, at least from a financial angle.

  A framework for predicting the future

  If you as a manager had the opportunity to design an appropriate advisory framework from scratch, it is likely that you would wish the design to help you to solve certain key problems which might hamper your effective decision-making. Perhaps the two key problems needing remedies might be:

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  Energy Management Handbook

  • Stephan A. Roosa, Steve Doty, Wayne C. Turner(Authors)
  • 2020(Publication Date)
  • River Publishers

    (Publisher)

  This might mean several thousand dollars to a small company or many millions to a large company. The ini-tial cost may occur as a single expenditure, such as pur-chasing a new geothermal heating and air conditioning system over a period of several years, or designing and constructing a new factory. Often the funds available for Capital Investments projects are limited. In other words, the sum of the initial costs of all the viable and attractive projects exceeds the total available funds. This creates a business situation known as capital ra-tioning, which imposes special requirements on the in-vestment analysis. The second important characteristic of a capital in-vestment is that the benefts (revenues or savings) accru -ing from the initial cost occur in the future, normally over a period of years. The period between the initial cost and the last future cash fow is the life cycle or life of the in-vestment. It is the attribute that multiple cash fows occur over the investment’s life that necessitates the introduc-tion of time value of money concepts to properly evaluate investments. If multiple investments are being evaluated and the life cycles of the investments are not equal, spe-cial consideration must be given to the issue of selecting an appropriate planning horizon for the analysis. The last important characteristic of capital invest-ments is that they are relatively irreversible. Frequently, after the initial investment has been made, terminating or substantially altering the nature of a capital invest-ment has cost consequences—usually negative. This is one of the reasons why capital investment decisions are usually evaluated at higher levels of the organizational hierarchy than are operating expense decisions.

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  Financial Management

  An Introduction

  • Jim McMenamin(Author)
  • 2002(Publication Date)
  • Routledge

    (Publisher)

  Many of these expenditures possess the characteristics of investment in fixed assets. They involve very substantial outlays, have long-term payoffs, and are vitally important for the survival and growth of a competitive firm. However, from a traditional financial accounting perspective, expenditures of this nature are not viewed as capital investment. They are instead treated as revenue expenditures and are charged against profits as they are incurred.

  While investment decisions of this nature do not add to the stock of real corporate assets, they are nonetheless vitally important to the firm's long-term survival and growth. Therefore it is our contention that they should be subject to the same type of rigorous investment appraisal process.

  Mandatory and discretionary investments

  Some Capital Investments will be mandatory ; that is, management will have no choice but to undertake the investment (e.g. to comply with health and safety and other legislation or to stay up with the competition) in order to remain in business. Other investments can be categorised as discretionary

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