Content area
Full Text
Steven S. Byers: Idaho State University, Pocatello, USA
John C. Groth: Texas A&M University, College Station, Texas, USA
R. Malcolm Richards: Texas A&M University, College Station, Texas, USA
Marilyn K. Wiley: Florida Atlantic University, Fort Lauderdale, Florida, USA
ACKNOWLEDGMENT: We thank anonymous reviewers for helpful comments and the Editor for his assistance.
Introduction
Selection of good capital projects is cardinal in efforts to add value to a company, to the economy and to society. The proper analysis of capital projects is essential. Leaders, managers and analysts have the responsibility for identifying, approving, managing or analysing potential capital investments.
Several factors motivate an understanding of the basics of investment analysis. First, the professional manager - regardless of functional speciality - benefits from a practical knowledge of the important elements of analysing and selecting capital projects. Second, a well-executed analysis often requires estimates best provided by those with functional area expertise and experience. For example, the analyst may call on the marketer to estimate sales levels at various prices or the production specialist and accountant to estimate variable costs of production.
This paper provides the conceptual basis, perspectives and guidelines for analysis of capital investments. The breadth and depth of presentation is appropriate for professionals regardless of functional area. On another occasion we will address specific nuances of investment analysis of particular interest to just the financial professional.
The discussion begins with a brief description of the nature and importance of capital investments, related issues of import to leaders and managers, and a review of important concepts. Next, the paper identifies important factors in capital investment analysis and provides practical guidelines for analysis. A practical format for analysis easily adaptable to spreadsheet analysis follows. Then we employ a technique of analysis to evaluate a sample capital project.
We interpret the results of the analysis in a common-sense manner and in terms of the contribution of the project to shareholder value. The paper closes with a summary and recommendations.
Background
Overview
Capital investments involve the exchange of capital in the form of cash for less liquid assets such as equipment, land and working capital. Recall working capital includes raw material, work-in-process and finished goods inventories and accounts receivable. Exchanging liquid cash at the present for illiquid assets which...