Capital Investments

MBA Program
(Course: MBA 614)

School of Business
Ahsanullah University of Science and Technology

(c) Dr Muhammad Abdul Mazid

2011
 Capital
Capital, capital goods, or real capital is a factor of production,
used to produce goods or services, that is not itself significantly
consumed (though it may depreciate) in the production process.
Capital is distinct from land in that capital must itself be
produced by human labor before it can be a factor of
production. At any moment in time, total physical capital may be
referred to as the capital stock, a usage different from the
same term applied to a business entity. In a fundamental sense,
capital consists of any produced thing that can enhance a
person's power to perform economically useful work - a stone
or an arrow is capital for a caveman who can use it as a hunting
instrument, and roads are capital for inhabitants of a city.
Capital is an input in the production function. Homes and
personal autos are not capital but are instead durable goods
because they are not used in a production effort
In classical economics, capital is one of three (or four, in some
formulations) factors of production. The others are land, labour
and (in some versions) organization, entrepreneurship, or
(c) Dr Muhammad Abdul Mazid
management. Goods with the following
2011 features are capital:
 Capital
Classifications of capital :
Social capital is the value of network trusting relationships between individuals in an
economy.
Individual capital, which is inherent in persons, protected by societies, and trades
labour for trust or money. Close parallel concepts are "talent", "ingenuity",
"leadership", "trained bodies", or "innate skills" that cannot reliably be reproduced by
using any combination of any of the others above. In traditional economic analysis
individual capital is more usually called labour.
Financial capital, which represents obligations, and is liquidated as money for trade,
and owned by legal entities. It is in the form of capital assets, traded in financial
markets. Its market value is not based on the historical accumulation of money
invested but on the perception by the market of its expected revenues and of the risk
entailed.
Natural capital, which is inherent in ecologies and protected by communities to
support life, e.g., a river that provides farms with water.
Spiritual capital, which refers to the power, influence and dispositions created by a
person or an organizations spiritual belief, knowledge and practice.
Infrastructural capital is non-natural support systems (e.g. clothing, shelter, roads,
personal computers) that minimize need for new social trust, instruction, and natural
resources. (Almost all of this is manufactured, leading to the older term manufactured
capital, but some arises from interactions with natural capital, and so it makes more
sense to describe it in terms of its appreciation/depreciation process, rather than its
origin: much of natural capital(c)grows back, infrastructural
Dr Muhammad Abdul Mazid capital must be built and
installed.) 2011
 Investment
Investment is putting money into something with the expectation of profit.
More specifically, investment is the commitment of money or capital to the
purchase of financial instruments or other assets so as to gain profitable
returns in the form of interest, dividends, or appreciation of the value of the
instrument (capital gains).[1] It is related to saving or deferring consumption.
Investment is involved in many areas of the economy, such as business
management and finance whether for households, firms, or governments. An
investment involves the choice by an individual or an organization, such as a
pension fund, after some analysis or thought, to place or lend money in a
vehicle, instrument or asset, such as property, commodity, stock, bond,
financial derivatives (e.g. futures or options), or the foreign asset
denominated in foreign currency, that has certain level of risk and provides
the possibility of generating returns over a period of time.
Investment comes with the risk of the loss of the principal sum. The
investment that has not been thoroughly analyzed can be highly risky with
respect to the investment owner because the possibility of losing money is
not within the owner's control. The difference between speculation and
investment can be subtle. It depends on the investment owner's mind
whether the purpose is for lending the resource to someone else for
economic purpose or not.

(c) Dr Muhammad Abdul Mazid

2011
 Investment
In economic theory or in macroeconomics, investment is the amount
purchased per unit time of goods which are not consumed but are to
be used for future production. Examples include railroad or factory
construction. Investment in human capital includes costs of
additional schooling or on-the-job training. Inventory investment
refers to the accumulation of goods inventories; it can be positive or
negative, and it can be intended or unintended. In measures of
national income and output, gross investment (represented by the
variable I) is also a component of Gross domestic product (GDP),
given in the formula GDP = C + I + G + NX, where C is
consumption, G is government spending, and NX is net exports.
Thus investment is everything that remains of total expenditure after
consumption, government spending, and net exports are subtracted
(i.e. I = GDP - C - G - NX).
Investment is often modeled as a function of Income and Interest
rates, given by the relation I = f(Y, r). An increase in income
encourages higher investment, whereas a higher interest rate may
discourage investment as it becomes more costly to borrow money.
Even if a firm chooses to use its own funds in an investment, the
interest rate represents an opportunity cost of investing those funds
rather than lending out that amount of money for interest.
(c) Dr Muhammad Abdul Mazid
2011
 Investment related to
business management:The investment decision (also known as
capital budgeting) is one of the fundamental decisions of business
management: Managers determine the investment value of the
assets that a business enterprise has within its control or
possession. These assets may be physical (such as buildings or
machinery), intangible (such as patents, software, goodwill), or
financial
Finance:, investment is the commitment of funds by buying
securities or other monetary or paper (financial) assets in the money
markets or capital markets, or in fairly liquid real assets, such as
gold or collectibles. Valuation is the method for assessing whether a
potential investment is worth its price. Returns on investments will
follow the risk-return spectrum.
Real estate as the instrument of investment: In real estate,
investment money is used to purchase property for the purpose of
holding, reselling or leasing for income and there is an element of
capital risk.

(c) Dr Muhammad Abdul Mazid

2011
 Capital Investment Analysis
and Project Assessment
Capital investment decisions that involve the purchase of items such as land,
machinery, buildings, or equipment are among the most important decisions
undertaken by the business manager. These decisions typically involve the
commitment of large sums of money, and they will affect the business over a
number of years. Furthermore, the funds to purchase a capital item must be
paid out immediately, whereas the income or benefits accrue over time.
Because the benefits are based on future events and the ability to foresee the
future is imperfect, you should make a considerable effort to evaluate
investment alternatives as thoroughly as possible. The most important task of
investment analysis is gathering the appropriate data.
Selecting investments that will improve the financial performance of the
business involves two fundamental tasks:
1) economic profitability analysis and
2) financial feasibility analysis.
Economic profitability will show if an alternative is economically profitable.
However, an investment may not be financially feasible: that is, the cash flows
may be insufficient to make the required principal and interest payments. So
one should complete both analyses before making a final decision to accept or
reject a particular project.
(c) Dr Muhammad Abdul Mazid
2011
 Capital Investment Analysis
and Project Assessment
Economic Profitability
The purpose of an economic profitability analysis is to determine whether
the investment will contribute to the longrun profits of the business. Although
various techniques can be used to evaluate alternative investments,
including the payback period and internal rate of return, the most 2 Purdue
Extension Knowledge to Go commonly accepted technique is net present
value, otherwise known as discounted cash flow.
Time Value of Money
The basic concept of a net present value procedure is that a dollar in hand
today is worth more than a dollar to be received sometime in the future. A
dollar is worth more today than tomorrow because todays dollar can be
invested and can generate earnings. In addition, the uncertainty of receiving
a dollar in the future and inflation make a future dollar less valuable than if it
were received today.
Net Present Value
Using these concepts of the time value of money, you can determine the net
present value (NPV) for a particular investment as the sum of the annual
cash flows discounted for any delay in receiving them, minus the investment
outlay (c) Dr Muhammad Abdul Mazid
2011
 Capital Investment Analysis
and Project Assessment
Step 1. Choose an appropriate discount rate to
reflect the time value of money.
Step 2. Calculate the present value of the cash
outlay required to purchase the asset.
Step 3. Calculate the benefits or annual net cash
flow for each year of the investments useful life.
Step 4. Calculate the present value of the annual
net cash flows.
Step 5. Compute the net present value.
Step 6. Accept or reject the investment.
(c) Dr Muhammad Abdul Mazid
2011
 Financial Feasibility
Once one has analyzed the profitability of
various investments and chosen an alternative,
he will need to evaluate its financial feasibility.
Financial feasibility analysis determines whether
or not the investment will generate sufficient
cash income to make the principal and interest
payments on borrowed funds used to purchase
the asset. If you will be making the purchase
with equity funds and a loan is not required, then
financial feasibility analysis is unnecessary.
(c) Dr Muhammad Abdul Mazid
2011
 Feasibility Calculation
The first step in financial feasibility analysis is to determine the annual net cash
flows for your project. Fortunately, you have already calculated these annual
flows as part of your economic profitability analysis. Next, you must determine
the annual principal and interest payments based on the loan repayment
schedule. Because the annual net cash flows are after-tax and the payment
schedule is before-tax, you must adjust this payment schedule to an after-tax
basis by calculating the tax savings from the deductibility of interest and
subtracting this savings from the payment schedule. Then, you compare the
annual net cash flow to the after-tax annual principal and interest payments to
determine if a cash surplus or deficit will occur.If a cash surplus results, the
investment project will generate sufficient cash flow to make the loan payments,
and the project is financially feasible as well as economically profitable. If a cash
deficit results, the project is not financially feasibleit will not generate sufficient
cash income to make the loan payments. Cash deficits do not mean that the
investment is unprofitable or should not be made; they simply mean that you will
likely encounter loan servicing problems.You can reduce or eliminate cash
deficits in a number of ways. Extending the loan terms (i.e., more years to repay
the principal) will result in lower annual debt servicing requirements, thus
reducing the deficit. Increasing the amount of the $15,971 (net income) x 35%
(marginal tax rate) = $5,590 (taxes)

(c) Dr Muhammad Abdul Mazid

2011
 Feasibility study

Feasibility studies aim to objectively and rationally

uncover the strengths and weaknesses of the existing
business or proposed venture, opportunities and threats
as presented by the environment, the resources required
to carry through, and ultimately the prospects for
success. In its simplest term, the two criteria to judge
feasibility are cost required and value to be attained.
Five common factors (TELOS)
Technology and system feasibility
Economic feasibility
Legal feasibility
Operational feasibility
Schedule feasibility

(c) Dr Muhammad Abdul Mazid

2011
 Feasibility study

Market and real estate feasibility

Resource feasibility
Cultural feasibility
Cultural feasibility
Financial feasibility
The feasibility study outputs the feasibility
study report, a report detailing the
evaluation criteria, the study findings, and
the recommendations.
(c) Dr Muhammad Abdul Mazid
2011
 Thank you
Thank you

(c) Dr Muhammad Abdul Mazid

2011