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Qualitative Considerations in Capital Investment Analysis:

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Learning objectives of this article:

  1. What are the qualitative considerations in capital investment analysis?
  2. Explain the importance of qualitative factors in capital investment analysis.

There are various methods of capital investment analysis that focus on quantitative aspects. Some popular methods are average rate of return, cash payback, net present value and internal rate of return method. Some of these methods focus on present values and some ignore it.

However, some benefits of capital investments are of qualitative nature. These benefits cannot be readily estimated in dollar terms. If management does not consider these qualitative considerations, the quantitative analysis may suggest the rejection of a worthy investment.

Example of Strategic Investment:

Nucor decided to be the first to invest in a new continuous casting technology that had the potential to make thin gauge sheet steel and thus open new product markets. This new investment was justified more on the strategic importance of the investment than on the economic analysis. As it turned out, the investment was very successful.

Qualitative considerations in capital investment analysis are very important for strategic investments. Strategic investments are those that are designed to affect a company's long term ability to generate profits. Frequently, strategic investments have many uncertainties and intangible benefits. Unlike capital investments that are designed to cut costs, strategic investments have very few hard savings. Instead they may affect the future revenue generating capabilities of the organization.

Capital investment analysis may be influenced by the following qualitative considerations:
  • product quality
  • manufacturing flexibility
  • employee morale
  • manufacturing productivity
  • manufacturing control

Today's manufacturing environment is characterized by investments in redesigning the manufacturing process and implementing manufacturing system such as just-in-time manufacturing and computer integrated manufacturing. In this manufacturing environment, qualitative factors may be especially important in capital investment analysis.

John H. McConnell, Chairman of Worthington Industries best summarized the importance of considering qualitative aspects of capital investments. He stated, "We try to find the best technology, stay ahead of the competition, and serve the customer...We'll make any investment that will payback quickly...but if it is something that we really see as a must down the road, payback is not going to be that important."

Joseph Morone and Albert Paulson, "Cost of Capital: The managerial Perspective," California Management Review (Summer 1991), pp. 9-32.

 

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More study material from this topic:

Methods for the evaluation of capital investment analysis
Average rate of return or accounting rate of return method
Cash payback method
Net present value method
Internal rate of return method
Simple interest
Future value of a single sum
Future value of an annuity
Present value of a single sum
Present value of an annuity
Qualitative consideration in capital investment analysis
Capital investment analysis and unequal proposal lives
Capital rationing decision process
Difference between simple interest and compound interest
Difference between nominal and effective interest rate
Future value of $1 table
Present value of $1 table
Present value of ordinary annuity table
Future value of ordinary annuity table

 

 
 

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Financial Accounting Topics


  Introduction to Accounting
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  Transactions and Accounting Equation
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  Analysis of Business Transactions
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  Journal, Ledger and Trial Balance
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  Special Journals
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  Cash Book
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Bank Reconciliation Statement
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  Work Sheet
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  Valuation of Inventories
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  Accounts of Non-profit Making Organizations
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  Activity Based Costing System
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  Standard Costing and Variance Analysis
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  Balanced Scorecard
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  Capital Investment Analysis/Capital Budgeting
 
 

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