Investment Appraisal Methods: A Guide to Assessing Capital

Investment AppraisalChapter -11 INTRODUCTION Capital expenditure often represents a significant investment by a company so it need to be assessed very carefully. A long term view of costs and benefits must be taken when reviewing a capital expenditure project. Capital expenditure: Expenditure incurred in acquisition of non-current assets. It is not charged to income statement although a depreciation charge will usually be made to write off the capital expenditure gradually overtime. Capital expenditure appears in statement of financial position. Revenue expenditure: Expenditure incurred for the purpose of trade off the business or to maintain the existing earning capacity of non-current assets. It is charged to income statement. Capital income: Income from the sale of non-current assets. Revenue income: Income from the sale of trading assets. It also includes interest and dividend received from investment held by the business. Capital expenditure budget: Capital expenditure budget is a long term plan and is considered very important for the business. Major expenses are required for it so most projects are considered individually and are fully appraised. Suitable finance must be arranged for capital expenditure. Capital expenditure should have appositive value for the business. Investment appraisal Investment appraisal techniques are required to determine: whether a new project should be accepted which of two (or more) projects to accept whether to lease or buy a new asset How to raise finance for the purchase of an asset Relevant and irrelevant costs The cost which is useful for decision making is known asrelevant cost. Relevant costing is used in long term decision making and investment decisions. The relevant costs are: Only cash items Future cash flows Incremental cash flows Following are the examples of some important relevant and irrelevant costs