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Summary of Contents
CAPITAL INVESTMENT APPRAISAL IN THE PUBLIC SECTOR
At the end of this guid or studying this lesson, you should have achieved the following learning objectives:
⦁ the nature of investment decisions.
⦁ the different methods of investimnent appraisal in the public sector
⦁ the procedures, advantages and disadvanteds of
i. cost-benefit analysis
ii. commercial investment appraisal approaches
iii. cost effectiveness analysis
⦁ risk and uncertainty factors in capital budgeting
⦁ solve the review questions at the end of the guide or lesson
SESSION 1: CAPITAL INVESTMENT APPRAISAL TECHNIQUES N THE PRIVATE SECTOR
1.1 Capital Investment Decision
Capital investment referes to the application of money or moneys worth in non current asset which is intended to provide a return by way of interest, dividend or capital application. the aim of capital investment includes maintenance (replacement of worn out or obsolete asset), profitability (spending to achieve cost savings, improvement in quality and productivity)., expension(spending to grow the business, making new products, open a new outlet, investment in R&D, etc).
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Capital investment inolves committing resources today to achieve gain tomorrow. though its is easy to determine how much will be committed today, there is some difficulty in accurately forecasting the gains from the investment in future. Going into a business therefore involves taking risks.
There is the need to therefore decide whether or not to commit funds today for the expected gain tomorrow. this decision is known as Capital Investment Decision. In taken such decision, there is the need to programme the capital expenditure to be incur covering several yeas which includes authorization of future projects and projects and under consideration.
this process is known as Capital Budgeting. The capital budgeting process includes;
⦁ projection and forecasting of capital requirement for the forthcoming period.
⦁ Identificatin of suitable alternatinve capital projects that meets the expenditure requirements.
⦁ Assessment of the cost and benefit of the alternative projects over their useful life. this process is known as capital investment appraisal.
⦁ Selection and approval of the best alternative project.
⦁ Make capital expenditure
⦁ Compare actual and planned spending and performance, investment of deviatins and monitoring benefits from the project over time.
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1.2 Features of capital Investment decision
1. Investment decision involves the exchange of current fund for future benefit.
2. It involves fund being invested in long term activities.
3. Cash flow from investment proposal is evaluated using one or more investment appraisal technique.
4. Investment decision is made based on predetermined acceptance criteria.
5. Investment decision has long term implication for the firm and may influence its risks complexion.
6. It involves a large commitment of fund and decisions once implemented become difficult to reverse.
1.3 Capital investment appraisal
Capital investment appraisal is an analysis of expected financial returns from a capital project over the expected life compared with the commitments made of the capital project to determine the financial viability of the project.
capital investment involves capital budgeting decision which is a decision of a firm to invest it current funds efficiently in a long term activities in anticipation of expected flow of future benefit over a series of years. long term activities in this sense may refer to those activities that affect the firms operation beyond a period of one year.
1.4 Capital investment Techniques
There are several methos of carrying out capital investment appraisal. However, the methos can be classified on the basis of whether the method takes into account the time value of money (the preference for receiving the same sum of money sooner rather than later). with this, the investment appraisal methods can be classified into Non-discounting cash flow method and discounting cash flow method.
A third category of investment appraisal techniques are those used i the government in appraising capital investments. Thus, the capital investment techniques include the following;
⦁ Non Discounting Cash Flow Techniques
a. Accounting Rate of Returns (ARR)
b. Payback Period (PBP)
⦁ Discounting Cash Flow Techniques
a. Net Present Value (NPC)
b. Discounted Pay Back Period
c. Internal Rate of Return (IRR)
d. Profitability Index.