Project Classification Types

Analyzing capital expenditure proposals is not a costless operation; benefits can be gained from careful analysis, but such investigations are costly. For certain types of projects, a relatively detailed analysis may be warranted; for others, cost/benefit studies suggest that simpler replacement projects

Maintenance of business investments cost reduction projects

Expenditures to replace obsolete plant and equipment safety and environmental projects

Mandatory nonrevenue-producing investments expansion projects

Expenditures to increase availability of existing products procedures should be used. Firms generally classify projects into a number of categories and analyze those projects in each category somewhat differently.

Replacement projects are expenditures necessary to replace worn-out or damaged equipment. These projects are necessary if the firm is to continue in its current businesses. The relevant issues are (a) Should the company continue to offer current products and services? and (b) Should existing plant and equipment be employed for this purpose? Usually, the answers to both questions are yes, so maintenance decisions are typically routine and made without going through an elaborate decision process.

Cost reduction projects include expenditures to replace serviceable but obsolete plant and equipment. The purpose of these investment projects is to lower production costs by lowering expenses for labor, raw materials, heat, or electricity. These decisions are often discretionary, so a more detailed analysis is generally required to support the expenditure. Decision-making authority usually rests at the manager or higher level in the organization.

Capital expenditures made necessary by government regulation, collective bargaining agreements, or insurance policy requirements fall into a further safety and environmental projects category. Such capital expenditures are sometimes called "mandatory" investments because they often are nonrevenue-producing in nature. How they are handled depends on their size and complexity; most often they are quite routine, and treatment is similar to replacement and cost reduction projects.

Expansion projects involve expenditures to increase the availability of existing products and services. For example, investment projects to expand the number of service outlets or distribution facilities are included in this category. These investment decisions are relatively complex because they require an explicit forecast of the firm's future supply and demand conditions. Detailed analysis is required, and the final decision is made at a high level within the firm, perhaps at the level of the controller or chief financial officer.

Expansion into new products or markets requires expenditures necessary to produce new products and services or to expand into new geographic areas. Strategic decisions that could change the fundamental nature of the firm's business are involved. Expenditures of large sums over extended investment horizons are often necessary. Final decisions are often made by the chief executive officer or board of directors.

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