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Introduction to Capital Investment Appraisal

What is Capital Investment?

Capital investment involves using the resources of a business to purchase or create longer-term assets — for example a new machine, building, or vehicle.

Capital investment appraisal — the use of accounting techniques to assess whether a capital project should be undertaken and, where there are alternatives, which option is best.

Cash Flows in Capital Investment

A capital project involves spending money now (Year 0) in order to receive net cash inflows in future years
Net cash inflow = cash receipts − cash payments arising from the project in that year
Year 0 = the beginning of the project; the initial capital outlay is shown here

CRITICAL: Do NOT include depreciation in cash flows. Depreciation is a non-cash transaction — it is an accounting adjustment, not a real cash movement. Including it would double-count the initial cost of the asset.

What to Include / Exclude

Include	Exclude
Initial cost of asset (Year 0 outflow)	Depreciation
Annual net cash inflows from the project	Sunk costs (already spent, irreversible)
Scrap/residual value at end of asset life	Allocated fixed overheads unaffected by the decision
Working capital changes	Non-cash accounting adjustments

The Two Methods

Method	What it measures
Payback period	How long it takes for cumulative net cash inflows to repay the initial investment
Net present value (NPV)	The total value of all future net cash inflows, discounted to present value, minus the initial cost