Evaluating the Return on Capital Expenditure

In Chapter 11 we discuss some of the reasons which motivate expansion. It is fair to say that management would not undertake expansion if it thought that the cost of this — both initial and annual — would exceed the additional income or revenue arising. What is much more likely is that the prospect of larger revenues, both in absolute terms and relative to the size of capital earning these returns (an increase in the ratio of profits to capital employed), is the stimulant for expanding the size of their organisation. This chapter is concerned with the techniques management use to choose between capital projects which are competing for limited capital resources and to decide whether a capital project is undertaken or not. The factors which control the administration of our capital budget have been discussed elsewhere, particularly in Chapter 7.