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Long Term Assets
- A Practical Approach
Drucker… The guru….
Investment Proposals
Divisional Divisional
Level Level
Investment Investment
Proposals Proposals
Capex
Appraisal
Top Management
Level
Filter
Investments Selected
Process of Capex Budgeting
Does it Relevant
Is it Yes Yes
vary with for
Futuristic?
alternative? Decision
Making
No No
Relevant
information
Irrelevant for Decision Making is futuristic& it varies
with alternative
Case: Choice between the
alternatives
- Total Cost Approach
Three years together
Work
Main frame station Difference
Revenue 30,000,000 30,000,000 -
Operating Costs:
Non-computer related operating costs 26,400,000 26,400,000 -
Computer related cash operating costs 1,200,000 300,000 900,000
Mainframe book value
Periodic write-off as depreciation 1,800,000 -
Or Lumpsum write-off - 1,800,000 -
Current disposal value - (950,000) 950,000
Workstations, written off as depr. - 1,350,000 (1,350,000)
Total operating costs 29,400,000 28,900,000
Operating Income 600,000 1,100,000 500,000
Case: Choice between the
alternatives
- Relevant Cost Approach
• Initial investment
– Cost of capital assets
– Installation costs
– Working Capital Margin
– Other startup expenses
Cash Flows
• Overstatement of Profitability
– Intentional Overstatement
– Lack of Experience
– Myopic Euphoria
– Capital Rationing
– Splitting the Proposal
• Understatement of Profitability
– Salvage values are under-estimated
– Intangible benefits are ignored
Total Cost Visibility
- The Iceberg Effect
Acquisition Poor
Cost Management
Repair
Cost
Training Specialties Technical
Cost Equipment Data
Cost Cost
Transportation
Supply & Handling
Support Retirement
Cost
Cost & Disposal
Cost
Facilities
Cost