DWIKY RAHADIAN MPS C 2011 41102066 CAPITAL EXPENDITURE DECISIONS

OBJECTIVES This chapter provides a broad overview of the field of project appraisal and capital budgeting. It is divided into five sections as follows: Capital expenditures: importance and difficulties Phases of capital budgeting Levels of decision-making Facets of project analysis Feasibility study: a schematic diagram Objectives of capital budgeting CAPITAL EXPENDITURE DECISIONS Capital Expenditures: Importance and Difficulties Importance Capital expenditure decisions often represent the most important decisions taken by a firm. Their importance stems from three inter-related reasons: Long-term effects: The consequences of capital expenditure decisions extend far into the future. The scope of current manufacturing activities of a firm is governed largely by capital expenditures in the past. Likewise current capital expenditure decisions provide the framework for future activities. Capital investment decisions have an enormous bearing on the basic character of a firm. Irreversibility: The market for used capital equipment in general is iIl-organised. Further, for some types of capital equipments,custom made to meet specific requirement, the market may virtually be non-existent. Once such an equipment is acquired, reversal of decision may mean scrapping the capital equipment. Thus, a wrong capital investment decision, often cannot be reversed without incurring a substantial loss Substantial outlays: Capital expenditures usually involve substantial outlays. An integrated steel plant, for example, involves an outlay of several thousand millions. Capital costs tend to increase with advanced. Difficulties

While capital expenditure decisions are extremely important, they also post difficulties which stem from three principal sources: .

Measurement problems: Identifying and measuring the costs and benefits of a capital expenditure proposal tends to be difficult. This is more so when a capital expenditure has a bearing on some other activities of the firm (like cutting into the sales of some existing product) or has some intangible consequences (like improving the morale of workers).

Uncertainty: A capital expenditure decision involves costs and benefits that extend far into future. It is impossible to predict exactly what will happen in future. Hence, there is usually a great deal of uncertainty characterising the costs and benefits of a capital expenditure decision. Temporal spread: The costs and benefits associated with a capital expenditure decision are spread out over a long period of time, usually 10-20 years for industrial projects and 20-50 years for infrastructural projects. Such a temporal spread creates some problems in estimating discount rates and establishing equivalences.

PHASES OF CAPITAL BUDGETING Capital budgeting is a complex process which may be divided into five broad phases: planning, analysis, selection, implementation, and review. Exhibit 11.1portrays the relationship among these phases. The solid arrows reflect the main sequence: planning precedes analysis; analysis precedes selection; and so on. The dashed arrows indicate that the phases of capital budgeting are not related in a simple, sequential manner. Instead, there are several feedback loops reflecting the iterative nature of the process. Planning The planning phase of a firm's capital budgeting process is concerned with the articulation of its broad investment strategy and the generation and preliminary screening of project proposals. The investment strategy of the firm delineates the broad areas or types of investments the firm plans to undertake. This provides the framework which shapes, guides, and circumscribes the identification of individual project opportunities.

Once a project proposal is identified, it needs to be examined. To begin with, a preliminary project analysis is done. A prelude to the full blown feasibility study, this exercise is meant to assess (i) whether the project is prima facie worthwhile to justify a feasibility study and (ii) What aspects of the project are critical to its viability and hence warrant an in-depth investigation.

Analysis If the preliminary screening suggests that the project is prima facie worthwhile, detailed analysis of the marketing, technical, financial, economic, and ecological aspects is undertaken. The questions and issues raised in such a detailed analysis are described in the following section. The focus of this phase of capital expenditure decisions is on gathering, preparing, and summarising relevant information about various project proposals which are being considered for inclusion in the capital budget. Based on the information developed in this analysis, the stream of costs and benefits associated with the project can be defined.

Selection Selection follows, and often overlaps, analysis. It addresses the question-Is the project worthwhile? A wide range of appraisal criteria have been suggested to judge the worthwhileness of a project. They are divided into two broad categories, viz., non-discounting criteria and discounting criteria. The principal non-discounting criteria are the payback period and the accounting rate of return. The key discounting criteria are the net present value, the internal rate of return, and the benefit cost ratio. The selection rules associated with these criteria are as follows: _________________________________________________________________ Criterion Accept Reject PBP> Target period ARR<Target rate NPV<0 IRR< cost of capital BCR<1 Accounting

Payback period(PBP) PBP< target period rate of return(ARR) ARR>target rate Net present value(NPV) Internal rate of return(IRR) Benefit cost ratio(BCR) NPV>0

IRR>cost of capital BCR>1

_________________________________________________________________ To apply the various appraisal criteria suitable cut-off values (hurdle rate target rate, and cost of capital) have to be specified. These essentially a function of the mix of financing and the level of project risk. While the former can be defined with relative ease, the latter truly tests the ability of the project evaluator. Indeed despite a wide range of tools and techniques for risk analysis (sensitivity analysis, scenario analysis, Monte Carlo simulation, decision tree analysis portfolio theory, capital asset pricing model, and so on), risk analysis remains the most intractable part of the project evaluation exercise.

Implementation The implementation phase for an industrial project, which involves setting of manufacturing facilities, consists of several stages: (i) project and engineering designs, (ii) negotiations and contracting, (iii) construction, (iv) training, and (v) plant commissioning. What is done in these stages is briefly described below _

________________________________________________________________ Stages Concerned with

Project and engineering designs Site probing and prospecting, preparation of blueprint and plant designs , plant engineering, selection of specific machineries and equipment. Negotiations and contracting Negotiating and drawing up of legal contracts with respect to project financing, acquisition of technology, construction of building and civil works, provision of utilities, supply of machinery and equipment, marketing arrangements, etc. Construction Site preparation, construction of buildings and civil works, erection and installation of machinery and equipment. Training of engineers, technicians, and workers. (This can proceed simultaneously along with the construction work) Start up of the plant. (This is a brief but commissioning is technically crucial stage in the project development cycle.)

Training

Plant commissioning

Translating an investment proposal into a concrete project is a complex time-consuming, and risk-fraught task. Delays in implementation,which is common, can lead to substantial cost overruns. For expeditious implementation at a reasonable cost, the following are helpful.

1. Adequate formulation of projects: A major reason for delay is inadequate formulation of projects. Put differently, if necessary homework in terms of preliminary studies and comprehensive and detailed formulation of the project is not done, many surprises and shocks are likely to Spring on the way. Hence, the need for adequate formulation of the project cannot be over-emphasised. 2. Use of the principle of responsibility accounting : Assigning specific responsibilities to project managers for completing the project within the defined time frame and cost limits is helpful in expeditious execution and cost control.

3. Use of network techniques: For project planning and control two basic techniques are available - PERT (Programme Evaluation Review Technique) and CPM (Critical Path Method). These techniques have, of late, merged and are being referred to by a common terminology, that is network techniques. With the help of these techniques, monitoring becomes easier.

Review Once the project is commissioned the review phase has to be set in motion. Performance review should be done periodically to compare actual performance with projected performance. A feedback device is useful in several ways: (i) It throws light on how realistic were the assumptions underlying the project; (ii) It provides a documented log of experience that is highly valuable in future decision-making; (iii) It suggests corrective action to be taken in the light of actual performance; (iv) It helps in uncovering judgemental biases; (v) It induces a desired caution among project sponsors.

MODAL KEPUTUSAN PENGELUARAN

Keputusan belanja modal sering mewakili keputusan yang paling penting yang dilakukan oleh perusahaan. Pentingnya mereka berasal dari tiga alasan yang saling terkait: 1. Efek jangka panjang: Konsekuensi dari keputusan belanja modal memperpanjang jauh ke masa depan 2. Ireversibilitas: Pasar untuk peralatan modal yang digunakan secara umum adalah iI lterorganisir pengeluaran Substansial: Pengeluaran modal biasanya melibatkan pengeluaran yang cukup besar. Pabrik baja terpadu, misalnya, melibatkan pengeluaran beberapa ribu juta. Biaya modal cenderung meningkat dengan maju. Kesulitan Sementara keputusan belanja modal sangat penting, mereka juga memposting kesulitan yang berasal dari tiga sumber utama:. Masalah Pengukuran: Mengidentifikasi dan mengukur biaya dan manfaat Ketidakpastian: Sebuah keputusan belanja modal melibatkan biaya dan manfaat yang memperpanjang jauh ke masa depan. Penyebaran Temporal: Biaya dan manfaat yang terkait dengan keputusan belanja modal tersebar selama periode waktu yang panjang, biasanya 10-20 tahun untuk proyek-proyek industri dan 20-50 tahun untuk proyek-proyek infrastruktur

TAHAPAN MODAL ANGGARAN Penganggaran modal adalah sebuah proses kompleks yang dapat dibagi menjadi lima tahap luas: perencanaan, analisis, seleksi, implementasi, dan ulasan.

1. Perencanaan Tahap perencanaan proses penganggaran modal perusahaan berkaitan dengan artikulasi strategi investasi yang luas dan pemeriksaan generasi awal dan proposal proyek. Strategi investasi perusahaan melukiskan daerah yang luas atau jenis investasi perusahaan berencana untuk melakukan. Ini memberikan kerangka yang membentuk, panduan, dan circumscribes identifikasi peluang proyek individu.

2. Analisa Jika penyaringan awal menunjukkan bahwa proyek ini prima facie berharga, analisis rinci dari pemasaran, teknis, aspek finansial, ekonomi, dan ekologi dilakukan. Pertanyaan dan permasalahan yang terjadi di seperti analisis rinci dijelaskan pada bagian berikut. Fokus dari tahap ini keputusan belanja modal pada mengumpulkan, mempersiapkan, dan meringkas informasi yang relevan tentang berbagai proposal proyek yang sedang dipertimbangkan untuk dimasukkan dalam anggaran modal. Berdasarkan informasi yang dikembangkan dalam analisis ini, aliran biaya dan manfaat yang terkait dengan proyek tersebut dapat didefinisikan. 3. Seleksi Seleksi berikut, dan sering tumpang tindih, analisis. Ini alamat pertanyaan-Apakah proyek berharga? Berbagai kriteria penilaian telah diusulkan untuk menilai worthwhileness proyek. Mereka dibagi menjadi dua kategori besar, yaitu, kriteria non-diskon dan kriteria diskon. Kriteria non-diskon utama adalah payback period dan accounting rate of return. Kriteria diskon kuncinya adalah nilai bersih sekarang, internal rate of return, dan rasio biaya manfaat. 4. Implementasi Tahap pelaksanaan untuk proyek industri, yang melibatkan pengaturan fasilitas manufaktur, terdiri dari beberapa tahapan: (i) proyek dan desain rekayasa, (ii) negosiasi dan kontrak, (iii) konstruksi, (iv) pelatihan, dan (v) tanaman komisioning. 5.Ulasan Tahap ini hanya mereview tahap-tahap sebelumnya