Page 591 - Sensors and Control Systems in Manufacturing

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Cha p te r
Ele v e n

Notice that use of probabilities enables the manager to reduce a
range of values to a single value. The manager can still retain for later
reference the original data used to make the estimate. The use of
probability measures, together with the data a manager must accu-
mulate, helps deal with the uncertainty that is characteristic of every
business operation.
11.4.4 Capital Budget
Capital is invested in a fixed asset only if the asset is expected to bring
in enough profit to (1) recover the cost of the equipment and (2) pro-
vide a reasonable return on the investment.
The purpose of a capital budget analysis is to provide a sound
basis for deciding whether the asset under consideration will in fact
do this if it is purchased.
The following elements must be considered in managing a capital
budget decision:
• The cost of the fixed asset
• The expected net cash flow provided by use of the asset
• The opportunity of investing funds in capital equipment
• The present value

11.4.5 Cost of the Fixed Asset
The cost of the fixed asset is usually comprised of the purchase price,
transportation, and installation cost of the asset. However, buying
the asset may mean that other investments will have to be made—
additional inventories, for example. If so, these too should be included
as part of the total investment outlay.

11.4.6 The Expected Net Cash Flow
The net cash flow may be either (1) the cash cost savings or (2) the
increased sales revenue minus the increased cash costs due to using
the new asset. No deduction for depreciation is made in calculating
cash flow.

11.4.7 Opportunity Cost
Opportunity cost is the return that the business could realize by
investing the money in the best alternative investment. For example,
if the best alternative is to place the money in a savings account that
pays 5 percent annually, the opportunity cost is 5 percent on the
amount of the investment.

11.4.8 The Present Value
Scientific capital budgeting is based on the concept of present value—
for example, $1.00 put in a savings account at 5 percent interest will