Capital investment decisions are crucial as their impact on a business is long term. Thus, it is important to evaluate the economic feasibility of the investment.
While making a capital investment, one must consider its impact on the profitability of the business in the long term. When estimating profitability, one needs to consider the time value of money. This concept is based on the fact that cash inhand is worth more than cash receivable at a future date. This is because currently-available cash can be invested to generate earnings, while the value of cash to be received in future can decline due to inflation.
A capital investment may result in an increase in revenues. However, revenue growth does not necessarily mean positive returns from the investment, since several factors, such as inflation, interest rates on loans and opportunity cost of money, need to be taken into consideration while calculating the returns.
One can determine the economic feasibility of a capital investment through the following steps: