15 - Investment appraisal

Summary

Capital investment and time horizons

Many technological improvements are embodied in new forms of durable capital. This clearly applies to machinery and equipment innovations and to new varieties of permanent crops and livestock. Land improvements in destumping, terracing or irrigation works also represent long-term investments. In all such cases an ordinary, single-period budget is inadequate for estimating resource needs and evaluating the investment.

Investment appraisal, or to use its other name, capital budgeting involves estimating resource inputs, costs and benefits over the whole lifetime of a medium- or long-term investment. Discounting techniques are then used to provide a single measure of the desirability of the investment. Costs and benefits are almost always measured in money terms, and this planning tool is most relevant to investments made for commercial gain. When a loan is sought from a formal credit agency, it is normal practice to submit a capital budget for the proposed investment in support of the application. Many credit banks require such a budget as proof of the viability of the investment before a loan is considered.

The purposes of investment appraisal are

1. (i) assessment of cash requirements for funding the investment;

2. (ii) provision of a financial plan to determine credit needs and the schedule of repayments;

3. (iii) evaluation of the investment, to determine whether it is financially viable and worth undertaking.

The method is closely similar to that of ‘project appraisal’ or ‘cost-benefit analysis’, used by economic planners to evaluate projects from the national point of view.