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Capital Investment Decisions Pt.1

Capital Investment Decisions Pt.1. Capital Investment Decisions (also known as Capital Budgeting) are decisions by businesses to invest in new fixed assets and grow the business. New Investments. Example of a Capital Investment Decision. Examples of Size of Capital Expenditure (CAPEX).

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Capital Investment Decisions Pt.1

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  1. Capital Investment Decisions Pt.1 Capital Investment Decisions (also known as Capital Budgeting) are decisions by businesses to invest in new fixed assets and grow the business.

  2. New Investments

  3. Example of a Capital Investment Decision

  4. Examples of Size of Capital Expenditure (CAPEX)

  5. Before we ask what investments to undertake, we need to ask what our objectives are?

  6. Alternative Investment Criteria

  7. Rates of Return

  8. Alternative Rates Introduced Below

  9. Calculating Operating Profit Depreciation * So AOP after depreciation = AOP – avg. Depreciation

  10. Investment Cost = £100,000 calculated Depreciation = (100 – 20)/5 = £16,00 per year Price = £12/unit Op. Cost = £8/unit Pre-Depreciation Operating Profit= (12 – 8) = £4/unit

  11. Example Cont. Calculating Op. Profit per Year And ARR after depreciation = (40 – 16) = £24,000 per year. So ARR before depreciation = (20 + 40 + 60 + 60 + 20)/5 = £40,000

  12. Average Investment The Average Investment (at 16/yr depreciation) = (100 + 84 + 68 + 52 + 36 + 20)/6 = £60,000 * Also calculated more simply as:

  13. Average Account Return Calculated * If this ARR is “high enough”, i.e. it exceeds the hurdle rate, then accept the project! Suppose the hurdle rate is 18%.

  14. The AAR Rule is perfect! What, Professor Chris? Not so fast, happy face. There are problems with the AAR rule!

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