Capital Investment Appraisal

Abstract

This chapter is concerned with capital expenditure in small businesses. Capital expenditure, which is expenditure typically on fixed assets such as plant and machinery, differs from other expenditure in two important respects. First, the benefits from the investment, whether in terms of labour savings or cash flow from additional profits, are likely to continue over a considerable number of years. Some technique is therefore needed to take account of the fact that cash flows in earlier years are more important than in later years. The principal reason for this difference is that cash received early on can earn interest and hence cannot be equated directly with an equivalent cash flow received later. Capital budgeting using proper discounted cash flow (DCF) techniques can take this time value of money into account. Much of this chapter will be concerned with an explanation of these techniques so far as they relate to small businesses. Secondly, the sums of money involved in the decisions are usually substantial and consequently more care needs to be exercised before committing the business to the purchase of the asset.