Question

1. Give an example of a qualitative factor that should be considered in a capital investment analysis related to acquiring automated factory equipment.

2. What are the major disadvantages of leasing a fixed asset rather than purchasing it?

Discuss the principle limitations of the cash payback method for evaluating capital investment proposals.

Answer 1

1.

Here are few of the Qualitative factors that need to be considered before acquiring automated factory equipment;

§ Researching the competition, realizing that you're probably not going to be privy to “the vision thing” that other small-business owners hold dear. Still, monitoring the operations, tactics and maneuvers of your rivals ought to be business as usual. And referring to the SWOT analysis in your marketing plan should help you flesh out the details. Intensifying your efforts prior to making a capital investment in technology could help you outwit, outfox and outpace your competitors – once and for all.

§ Consulting your stakeholders, especially your employees and customers. If you approach them in a sincere and thoughtful manner, they should be more than happy to tell you what they need, and want, to improve your product or service offering. Like many small-business owners, you may not be able to make every tech investment at once. But gaining stakeholder insights can help you prioritize and communicate your progress to them, in good faith, while the investments materialize. (It's good PR, too.) Since your customers probably hold the future of your business in their hands, they could be the most influential of all the non- monetary factors in your decision making.

§ Looking beyond the actual implementation. Whether your goal is to reduce the time your staff spends on repetitive tasks, secure your business data or provide a better customer experience, investing in technology is rarely one of those “one-hit wonders” – a quick fix that you can institute and then put in the rear-view mirror. It will probably require more maintenance, which means a regular financial investment in staff time or outsourcing. Since you have a good head for numbers, this realization shouldn't be unsettling. Try to remember that, as always, it's the human dimension that will tilt the scale of success in your favor. Research shows that businesses grow best when technology and human beings work together to meet customers' needs – and that's a qualitative factor worth banking on.

2.

Disadvantages of Leasing Fixed Asset

Higher overall cost. Leasing an item is almost always more expensive than purchasing it. For example, a 3-year lease on a computer worth $4,000, at a standard rate of $40/month per $1,000, will cost you a total of $5,760. If you had bought it outright, you would have paid only $4,000.

You don't own it. You don't build equity in the equipment. Unless the equipment has become obsolete by the end of the lease, this lack of ownership is a significant disadvantage.

Obligation to pay for entire lease term. You are obligated to make payments for the entire lease period even if you stop using the equipment. Some leases give you the option to cancel the lease if your business changes direction and the equipment you leased is no longer necessary, but large early termination fees always apply.

Buying Equipment

Ownership and tax breaks make buying business equipment appealing, but high initial costs mean this option isn't for everyone

3.

Object Of Pay Back Method

The object of the payback method is to determine the number of years that it takes to recover the initial investment. The formula is to take the initial investment and divide by cash flow per year:

Payback in the number of years = Initial Investment/Cash flow per year

Principle limitations on cash Payback Method for evaluating capital investment proposals

Ignores the time value of money: The most serious disadvantage of the payback method is that it does not consider the time value of money. Cash flows received during the early years of a project get a higher weight than cash flows received in later years. Two projects could have the same payback period, but one project generates more cash flow in the early years, whereas the other project has higher cash flows in the later years. In this instance, the payback method does not provide a clear determination as to which project to select.

Neglects cash flows received after payback period: For some projects, the largest cash flows may not occur until after the payback period has ended. These projects could have higher returns on investment and may be preferable to projects that have shorter payback times.

Ignores a project's profitability: Just because a project has a short payback period does not mean that it is profitable. If the cash flows end at the payback period or are drastically reduced, a project might never return a profit and therefore, it would be an unwise investment.

Does not consider a project's return on investment: Some companies require capital investments to exceed a certain hurdle of rate of return; otherwise the project is declined. The payback method does not consider a project's rate of return.

They payback method is a handy tool to use as an initial evaluation of different projects. It works very well for small projects and for those that have consistent cash flows each year. However, the payback method does not give a complete analysis as to the attractiveness of projects that receive cash flows after the end of the payback period. And it does not consider the profitability of a project nor its return on investment