Question

There are primary and secondary decision tools when evaluating capital expenditure projects. What are some of the considerations that a finance manager should take into account when deciding whether the firm should embark on a project and why?

Answer 1

A manager should always remember that he should undertake a project only if the project has a positive NPV. Based on this fact following points can be made -

1. Even 1$ positive NPV indicates that a project must be undertaken.
2. For NPV to be positive Cost of Capital for the new project must be less than the return generated by the project.
3. Correctly estimating all the assumptions, like life of proect, cost of equity, cost of debt etc is important to asses correct value of NPV.
4. However, one fact which is not considered by NPV is the liquidity situation of the firm, if all the cashflow from the project is coming a bit too late, it might cause liquidity risk for the project in the initial years.
5. Manager should also asses the Working Capital situation for the project. If short term loans are utilized for long term project, it might be a recipe for disaster.
6. Manager should also consider the repair and maintenance as part of evaluation of the CAPEX project.