Capital and Revenue Expenditure

Question 1

What is Capital expenditure and what is Revenue expenditure?

Answer 1

Capital expenditure is;
- Cash on investment in the business
- factories
- IT systems
- machinery
- 'improve or expand what you have' 
Revenue Expenditure;
- day to day operations
- raw materials
- energy costs
- marketing costs
- 'maintenance of business'

Question 2

Why would a business spend money on Capital Expenditure?

Answer 2

• extra production capacity
• replacement of machinery
• complying with regulation

Question 3

What is investment. appraisal?

Answer 3

• the process of analysing whether investment projects are worthwhile.
• Payback period
• Accounting Rate of Return (ARR)
• Net Present Value (NPV)

Question 4

What is Net Present Value?

Answer 4

• NPV calculates monetary value now of the projects future cash flows

Question 5

What are the pros and cons of NPV?

Answer 5

ADV:
- takes account of time and the fact that monetary value is likely to fluctuate in the future
- The NPV method also tells us whether an investment will create value for the company or the investor, and by how much in terms of money.
CONS:
- complicated method
- hard to calculate an appropriate discount rate
- The NPV calculation is very sensitive to the initial investment cost

Question 6

What is Accounting Rate of Return (ARR)?

Answer 6

• The average rate of return (ARR) method looks at the total accounting return for a project to see if it meets the target return rate.

Question 7

How is ARR (%) calculated?

Answer 7

ARR(%) = (total net profit / no. years) / Initial Cost = x 100

Question 8

What are the Benefits to ARR?

Answer 8

• ARR provides a % return which can be compared with a target return
• ARR looks at the whole profitability of the project
• focuses on profitability a key issue for shareholders.

Question 9

What are the Drawbacks to ARR?

Answer 9

• Does not take into account cash flows – only profits (they may not be the same thing)
• Takes no account of the time value of money
• Treats profits arising late in the project in the same way as those which might arise early

Question 10

How do you calculate NPV?

Answer 10

• :
  Net present value (NPV) is a method of determining the current value of all future cash flows generated by a project after accounting for the initial capital investment. It is widely used in capital budgeting to establish which projects are likely to turn the greatest profit.

The formula for NPV varies slightly depending on the consistency with which returns are generated. If each period generates returns in equal amounts, the formula for the net present value of a project is:

NPV = C * {(1 - (1 + R) ^ -T) / R} − Initial Investment

where C is the expected cash flow per period, R is the required rate of return and T is the number of periods over which the project is expected to generate income.

However, many projects generate revenue at varying rates over time. In this case, the formula for NPV is:

NPV = {C for Period 1 / (1 + R) ^ 1} + {C for Period 2 / (1 + R) ^ 2} … - Initial Investment

Question 11

What are some different aspects to risk of project?

Answer 11

• length of project
• source of the data
• size of investment
• economic and market environment
• experience of management

Question 12

What are some qualitative factors to consider?

Answer 12

• impact on employees
• product quality and customer service
• consistency of the investment decision with corporate objectives
• the business’ brand and image, including reputation
• implications for operations, including any disruption or change to the existing set up
• responsibilities to society and other external stakeholders