ABSTRACT
The economic analyses described in Chapter 5 have related to schemes whereby only the expenditure was considered. The purchase price and running or operating costs were not offset in the calculations against any revenue, and the only monies returning to the investor were from resale. Thus, the previous analyses were confined to determining whether one course of action – say the purchase of one particular item of equipment – was more economic than another course of action, the purchase of an alternative item. What will be considered now is the situation where the equipment generates a revenue. The simplest situation to imagine is where the equipment is purchased and hired out so that the owner has capital expenditure, operating costs, revenue and resale value. The analysis required now is not simply whether one item is more economic than another but whether the item is earning an adequate return on the invested capital. That is, whether the return on capital derived from owning and hiring out equipment is better than could be obtained from less risky investment elsewhere or, if the capital to buy the equipment is borrowed, whether the return is greater than the cost of capital as measured by the interest on the capital. The capital made available by the organisation to purchase the equipment should earn at least the minimum return expected by the organisation. This analysis, therefore, requires that the rate of return be measured and the most widely used method is known as the ‘internal rate of return’, ‘yield’ or ‘discounted cash flow (DCF) yield’. All these are names for the same measure of profitability.
