| Introduction
Because capital expenditure decisions
involve significant resources that are committed long into the
future, considerable time and effort should go into the evaluation
of plant asset proposals. The length of time that financial
resources are committed makes capital expenditures more risky than
other investments. Before beginning a capital expenditure program
that involves a large outlay of funds that will be tied up for many
years, management should seek assurance that they will receive an
acceptable return on investment. In order to quantitatively select
from several options, the predicted cash flows must be compared to
the required investments to determine if the return generated from
each option meets or exceeds what management considers acceptable.
The purpose of this Return on Investment (ROI) Kit is to assist your
company in evaluating whether your refrigerated warehouse needs can
best be met through construction of your company’s own distribution
center, (referred to in this Kit as “private warehouse space”), or
through use of one of the many public facilities available
worldwide. In other words, is it better to construct your own
facilities or “outsource” for space in public refrigerated
warehouses?
Several techniques are available
for evaluating capital expenditure proposals. This ROI Kit helps to
organize factors to be considered in the capital expenditure
decision, and provides worksheets to document your calculation of
two commonly used methods. These two methods consist of:
Return on Investment: This
calculation, also known as the book value rate of return, is
commonly used because it is based on the accrual method of financial
statement preparation, and is easy to apply. Its weakness is that is
fails to consider the time value of money. The investment to be
evaluated is the investment you would make if your company met its
refrigerated storage needs by constructing your own refrigerated
warehouse. The return on this investment will be defined as the
difference between the annualized cost of building and operating
your private refrigerated warehouse vs. the annual cost of using
public refrigerated warehouse capacity.
Net Present Value: Present
value is a way of re-stating a stream of future cash flows into
today’s dollars. When present value is applied to a capital
investment, the future return is generally in the form of cash
generated by the asset acquired. This model, however, calculates the
net present value (NPV) of the cash outflows related to each option.
All other factors being equal, the option with the lower present
value cost is generally the most profitable decision.
Completion of this Kit:
This Kit has been organized into
two sections and worksheets to help you in collecting the
appropriate data for performing each of these two calculations. Use
of this kit assumes that you have already assembled the projected
capital investment and operating costs of building and operating
your own warehouse. Should you need assistance in assembling that
information, however, supplemental schedules A and B have been
included for your use in generating that information. To simplify
these calculations, the Kit has been generated in an Excel
95-diskette format to include Worksheet #1 for calculation of ROI,
and Worksheet #2 for calculation of NPV.
For simplicity, cash flow
projections in Worksheet #2 assumes that all capital expenditures
are incurred in the first year, and operating expenses are incurred
equally over the time period selected by you to perform the net
present value analysis.
Public refrigerated warehousemen
would appreciate the opportunity to assist you in completing this
Kit by providing an estimate of the annual expense you would incur
if you used the services of their refrigerated warehouses. Their
experience may also prove valuable in accumulating all appropriate
costs associated with building and operating refrigerated
warehouses. They can also provide comparative statistical data in
other areas of the decision analysis.
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