Capital Investment Management Analysis

Introduction

Capital Investment

Capital investments often involve long term policies and strategic plans in which an organization commits to undertake heavy investments. Since the company intends to undertake capital expenditure will have to spend a lot of financial resources, great analysis is no doubt required. A type of budget referred to as capital budgeting is often undertaken. (Mowen, 2011) Capital budgeting involves tasks of planning how to utilize capital resources available to the firm with a view to maximizing the firm’s profitability in the long run. Capital investment decisions are among the most difficult tasks that managers encounter. This is due to the peculiar nature of capital expenditure projects. Capital investment requires a commitment of a company’s funds for the long term, like four years or more. Consequently, the elements of risk and uncertainty are nearly guaranteed in capital expenditure decisions.

Detailed research is normally conducted to assess the viability of the project before investing. This kind of research is referred to as project appraisal. Project appraisal is the mechanism of considering the cost and expected benefits of an item of capital expenditure over a period of time, which should be more than one financial year. (Albrecht, 2011) Acceptability of an investment is based on its benefits. The benefits arising from such a project must cover up the costs incurred by far. It is worth noting that benefits are not always monetary quantified. It is possible to have a project whose projections indicate positive returns yet it cannot be accepted. However, profitability forms the central point in project appraisal. Methods of assessing financial acceptability of a fixed asset include the Internal Rate of Return (IRR), payback method, net present value, and the discounted cash flow method.

Nonfinancial elements that determine project acceptability include ethical issues, legal issues, regulation changes, political factor, competition level, environmental issues, and quality implication among others. All stakeholders have to be satisfied behold reasonable doubt that the asset will accrue some benefits to that regard.

This essay will carry out a detailed evaluation of a capital project, using an X-ray machine for any given health facility as our case study.

Discussion

As discussed above in the introduction bit of this essay, capital expenditure requires heavy financial outlay and thorough research has to be conducted in order to ascertain whether to accept or not a decision to acquire a fixed asset. Acceptance is determined by whether the X-ray equipment will be profitable to the clinic or not; whether it will have environmental implications; ethical issues that underlie; the effect it will have to the staff and technical considerations.

One of the main techniques applied by accountants in screening preference for a decision is the investment’s internal rate of return. This refers to the return rate of an investment over useful life. Internal rate of return refers to the discount rate for the cash inflow of the project. For instance, assuming there is some capital outlay at the start of the project, with cash inflows expected after some few years which are higher than the initial fund’s outflow a bigger rate of discount would be employed to equate the two inflows. The project is selected by the management only if the internal rate of return is greater than the required rate of return. For example, a project could be having an internal rate of return of 6.7%, while the management has set their standard rate of return as 9.0%. This means the project’s profitability is positive.

Another technique applied to select capital investment is the net present value of the project. This entails discounting of the future cash inflows and the cash outflows at a given discount rate, thereby arriving at the net present value of the X-ray project. Again, the discounting rate is determined by the enterprise and could be based on the cost of capital. Acceptability is determined by whether the NPV is positive or not. (Mowen, Cornerstones of managerial accounting, 2012) For a decision to be acceptable, the NPV of the X-ray machine MUST be positive.

A further technique that could be employed in screening the project is the payback technique. This considers the time required for the X-ray machine to cover its initial cost from the cash inflows generated. A payback period may be set by the management on which the decision for acceptance or rejection is based. This method only considers the time aspect only and ignores the profitability aspect. As long as the time for recouping our outlay does not exceed the set period, then the project could be accepted.

Other than financial considerations, there are other factors which have to be put into test. For example, we have to ask ourselves whether the equipment will have adverse environmental implications. This could be through emissions, noise, etc. we have also to put into consideration factors like the reaction of the staff towards the initiative. (Besley, 2008) Will the acquisition of the x-ray machine negatively affect the staff morale or it will boost it? Will they accept it or not? Another factor to consider is the technical aspect of the machine. We have to ascertain whether the hospital has sufficient technical resources to handle this x-ray facility.

For instance, are the available health staff skilled to handle and operate the system or the hospital has to recruit someone and If it has to recruit someone from outside, how are there availability and willingness? Again this takes us back to the element of financial screening since we have to factor in the cost of remuneration for the extra staff and some training. Should the machine break down, what are the possible implications to the image of the hospital? Is there adequate personnel required to service and carry out maintenance of the equipment? We also have to ask ourselves whether there are political factors like change of government that are likely to affect our project. If the management is satisfied with these factors, then a go-ahead is given to the project committee.

According to the results of the technology of a pilot Bulk X-Ray issued on 3^rd December 2012, some financial revelations were made following the acceptance of the project. The study or rather the project pertains the application of the project of Bulk X-ray in Rockwell Company. We are told that, although the project was meant for a pilot study, it had already repaid all the costs and capital expenditures incurred with respect to its acquisition as well as costs of having it set up.

The project is said to have been initiated in 2011and that it was commissioned after five months indicating a capital outlay of 7% which is lower than the original budgeted figure of $1.5 million. Over the period of six months up to the date of publishing of the report, we are told that carats totaling to 1596 had been recovered through reprocessing approximately 27609m3 of the old tailings recovered, which had been processed by another firm but using somehow older technologies. These factored in three specifically large stones that weighed 52, 145 and 72 carats respectively.

Besides the capital expenditure of $1.4 million, operating expenses amounting to $0.39 million were also incurred. Subsequent revenues from the sales of diamonds recovered added to the US $4.2 million for a period covering up to the end of October 2012. Diamond recovery from those tailings shows that the acceptability and application of this technology should give rise to additional recoveries. The publisher said that the CEO of the company expressed great pleasure to see their initial outlay having been paid back.

A different report embarked on analyzing the results of such a project in terms of improving satisfaction and saving time. The purpose of the study was to evaluate the effects of the transition to digital radiology at UC Davis Health System. The study concerned with analyzing the costs and workflow, surveys of physician satisfaction as well as radiology interactions that are self-recorded by the on-call residents. We are told that before the implementation of the machine, physicians would spend as much as one to three hours looking for films on a daily basis and that they were totally dissatisfied with the services of the radiology.

After installation, those images became readily available and now physicians would carry out viewing and interpretation of images themselves and expressed much satisfaction. The study revealed that the time for image search reduced to 2 minutes all the way from 16 minutes which translated to saving of 21.5 years of physician valued at $1034150 yearly. The decline in the printing of film was estimated to be 73.4% and full time for file clerks equivalent 50.3%, thereby saving $1001452yearly. It also indicated that square feet amounting to 8108 warehouses and 1218 hospital were also freed. This estimated to a value of $2018320. As a result, physicians’ morale was highly boosted.

All the various modes of medical imaging can be fruitful to patients. The overriding concern of the medical doctors and the radiology department of hospitals is to ensure that the benefits that arise from making the right diagnosis and giving you the correct treatment far outweigh any potential risk. Instead of being concerned with the small risks that arise due to x-ray exposure, one should inquire from their doctors how useful the information they obtain through radiology will be towards their diagnosis.

If decisions to treat by the doctor largely depend on the results, then the risk to your body of not undergoing the x-ray is far much higher than that of staying without a diagnosis. everyone is exposed to radiation from the natural background on every day of our lives. The study has established that in Ireland, radiation exposure is mainly due to radon gas that is said to seep from the underground and accumulates in houses.

Another study has revealed that 16% of the radiation gas comes from rocks from the ground. 14% results from cosmic rays while 12 percent is generated from the foodstuff we feed on. Therefore, we can not completely ignore x-ray services with the argument that they contribute to harmful radiations. Every effort is being made in radiology departments to have radiation doses kept as low as possible and where necessary to employ ultrasound which emits no hazardous radiation.

X-ray light is more harmful to young children and unborn babies, and less harmful to older people. This shows that one of the risks the management will face is on how to manage this risk. Policies have to be put into place especially in the radiology department so that the system does not taint the image of the organization through negligence.

There is yet another risk that financial screening made could have been subjective. It is a matter of fact that financial projections made may not fully reflect the true picture. For example, a discounting rate that was determined on the basis of the prevailing rate of the cost of capital will be affected by conditions like inflation. This means our financial evaluations will give us different results. It is, therefore, necessary for the management to remain flexible. Moreover, it is recommended that proper monitoring of the project be carried out regularly and report given to ensure that the flow is smooth.

At times, capital investments are faced with a big challenge of budgeting costs. Budgeting and managing key capital investment programs have proved to be a hard thing for most organization. Due to this, key stakeholders will want to be told about every detail. They will want to know how the company identifies and manages risks among other questions. In many entities, it has been established that cost overruns arise due to factors that may be beyond the control of the organizations. These may include commodity prices rising, litigation, insurance costs, inability to accurately forecast demand and supply, natural disaster, environmental protection costs, etc.

In our project, management is charged with the responsibility of employing all possible policies to ensure that the project runs as planned while minimizing all risks inherent. Cost forecasting cannot be overemphasized in this regard. Some of the possible measures include ensuring centralized reporting, projecting high/ low annual achievements, re-forecasting at least on a quarterly basis depending on the stage of completion of the project, tracking expenditure authorization, monitoring the project closely.

Other risks that may arise include credit risk. For this one, it is advisable to get an insurance cover for the project if necessary.

Conclusion

This paper has widely tackled matters of capital expenditure. We began by defining capital expenditure as a long term plan in which an organization commits significant financial resources into. Capital investment decisions are among the most difficult tasks that managers encounter and largely determine the life of an organization, hence need for thorough research before approving the proposal. This is due to the peculiar nature of capital expenditure projects.

Capital investment requires a commitment of a company’s funds for the long term and usually extend for a long duration of time, often more than a year. Consequently, the elements of risk and uncertainty are nearly guaranteed in capital expenditure decisions. As discussed above, risks will arise due to some factors part of which the management may not have control over, for example, disaster. Other risks are political up heal, changes in economic systems, the legal environment may also come out with a law negatively affecting our project, etc.

To warrant acceptability by the financiers, the appraisal report must sound financially feasible. This essay has outlined various ways to assess the financial profitability of the project. However, there are some factors which have to be analyzed and their effect measured though they are not financially quantifiable. These non- monetary elements include the reaction of employees, neighboring community, etc. This essay has discussed the main financial methodologies to evaluate the profitability of a project. They include the Net Present Value technique.

This entails discounting of the future cash inflows and the cash outflows at a given discount rate, thereby arriving at the net present value of the X-ray project. Again, the discounting rate is determined by the enterprise and could be based on the cost of capital. Acceptability is determined by whether the NPV is positive or not. For a decision to be acceptable, the NPV of the X-ray machine MUST be positive. The payback period is also another technique used. It just ensures that the project investment funds are recovered within a given period of time.

The essay has also looked into other areas where study and research have indicated that the project of a similar nature was undertaken and it actually succeeded. Risks inherent to this project have been analyzed, for example, budget cost overruns and how to involve management in minimizing the impact, for example through proper monitoring of the project, involving the staff in the project committee so that it receives acceptance from within.

Work Cited

Albrecht, W. S. (2011). Accounting, concepts & applications: what, why, how of accounting. Mason: South-Western/Cengage Learning.

Besley, S. (2008). Essentials of managerial finance. Mason, OH: Thomson/South-western, Mason, OH: Thomson/South-western.

Mowen, M. M. (2011). Cornerstones of cost accounting. Mason: Cengage Learning.

Mowen, M. M. (2012). Cornerstones of managerial accounting. Mason: South-Western Cengage Learning.

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