ABSTRACT
Because of the risks involved with capital expenditure, capital investment appraisal (CIA) techniques have evolved to inform and underpin the decision making process. When we borrow money to fund a new project we need to know that we can afford to pay back the loan (or principal) as well as any interest we have to pay to service the loan. We also need to make sure that we do not run out of money and can pay
our liabilities as they fall due. In this regard, CIA is concerned with the total investment needs of a project. When a gym is being constructed it will need staff to market it and sell memberships even though the facility is not yet open. Therefore money will also be required to fund these day-to-day expenses as well as the purchase of fixed assets. Regardless of how good our business ideas might seem to us, there is no guarantee that funders will see things in the same way. The reality is that funding for capital investment will be limited in supply relative to the demand for it and therefore will be rationed. This means that in practice only the most advantageous loans for the banks will be made, where advantageous is a function of the likelihood of being paid and the amount of interest that can be charged. It is therefore vitally important that those people looking to make capital investment decisions do so on the basis of a sound business case. This then brings us to the purpose of capital investment appraisal which can be described as comparing the cost of a project now (the investment) with the expected benefits (returns) that will accrue in the future. The chances are that you are reading this book because you have made a decision to invest in your education now, with the expectation that your future lifetime earnings will compensate for the time you took out to go to university and the fees you incurred in so doing. In short the purpose of CIA can be summarized as follows:
■ to test the financial viability of a project; and ■ to rank different projects so that limited funding is allocated to the best project.
