Financial Terms capital investment analysis

# Definition of capital investment analysis

## capital investment analysis

Refers to various techniques and procedures
used to determine or to analyze future returns from an investment
of capital in order to evaluate the capital recovery pattern and the
periodic earnings from the investment. The two basic tools for capital
investment analysis are (1) spreadsheet models (which I strongly prefer)
and (2) mathematical equations for calculating the present value or
internal rate of return of an investment. Mathematical methods suffer
from a lack of information that the decision maker ought to consider. A
spreadsheet model supplies all the needed information and has other

# Related Terms:

## capital recovery

Refers to recouping, or regaining, invested capital over
the life of an investment. The pattern of period-by-period capital recovery
is very important. In brief, capital recovery is the return of capital
not the return on capital, which refers to the rate of earnings on the
amount of capital invested during the period. The returns from an
investment have to be sufficient to provide for both recovery of capital
and an adequate rate of earnings on unrecovered capital period by
period. Sorting out how much capital is recovered each period is relatively
easy if you use a spreadsheet model for capital investment analysis.
In contrast, using a mathematical method of analysis does not
provide this period-by-period capital recovery information, which is a

## cost of capital

Refers to the interest cost of debt capital used by a business
plus the amount of profit that the business should earn for its equity
sources of capital to justify the use of the equity capital during the
period. Interest is a contractual and definite amount for a period,
whereas the profit that a business should earn on the equity capital
employed during the period is not. A business should set a definite goal
of earning at least a certain minimum return on equity (ROE) and compare
its actual performance for the period against this goal. The costs of
debt and equity capital are combined into either a before-tax rate or an
after-tax rate for capital investment analysis.

## discounted cash flow (DCF)

Refers to a capital investment analysis technique
that discounts, or scales down, the future cash returns from an
investment based on the cost-of-capital rate for the business. In essence,
each future return is downsized to take into account the cost of capital
from the start of the investment until the future point in time when the
return is received. Present value (PV) is the amount resulting from discounting
the future returns. Present value is subtracted from the entry
cost of the investment to determine net present value (NPV). The net
present value is positive if the present value is more than the entry cost,
which signals that the investment would earn more than the cost-ofcapital
rate. If the entry cost is more than the present value, the net
present value is negative, which means that the investment would earn
less than the business’s cost-of-capital rate.

## "Soft" Capital Rationing

capital rationing that under certain circumstances can be violated or even viewed
as made up of targets rather than absolute constraints.

## activity analysis

the process of detailing the various repetitive actions that are performed in making a product or
providing a service, classifying them as value-added and
non-value-added, and devising ways of minimizing or eliminating

Amounts in excess of the par value or stated value that have been paid by the public to acquire stock in the company; synonymous with capital in excess of par.

Any payment received from investors for stock that exceeds
the par value of the stock.

Difference between issue price and par value of stock. Also called capital surplus.

## Aggressive Capitalization Policies

capitalizing and reporting as assets significant portions of
expenditures, the realization of which require unduly optimistic assumptions.

## Aggressive Cost Capitalization

Cost capitalization that stretches the flexibility within generally
accepted accounting principles beyond its intended limits, resulting in reporting as assets
items that more reasonably should have been expensed. The purpose of this activity is likely to
alter financial results and financial position in order to create a potentially misleading impression
of a firm's business performance or financial position.

## authorized share capital

Maximum number of shares that the company is permitted to issue, as specified in the firm’s articles of incorporation.

## Average cost of capital

A firm's required payout to the bondholders and to the stockholders expressed as a
percentage of capital contributed to the firm. Average cost of capital is computed by dividing the total
required cost of capital by the total amount of contributed capital.

## BARRA's performance analysis (PERFAN)

A method developed by BARRA, a consulting firm in
Berkeley, Calif. It is commonly used by institutional investors applying performance attribution analysis to
evaluate their money managers' performances.

## Break-even analysis

An analysis of the level of sales at which a project would make zero profit.

## break-even analysis

analysis of the level of sales at which the company breaks even.

## Break-Even Analysis

An analytical technique for studying the relationships between fixed cost, variable cost, and profits. A breakeven chart graphically depicts the nature of breakeven analysis. The breakeven point represents the volume of sales at which total costs equal total revenues (that is, profits equal zero).

The use of capital to create more money through the addition of fixed assets or through income producing vehicles.

## Capital

Money invested in a firm.

## CAPITAL

The money, raised by selling stock or bonds or taking out loans, that you use to start, operate, and grow a business.

## Capital

The shareholders’ investment in the business; the difference between the assets and liabilities

## capital

A very broad term rooted in economic theory and referring to
money and other assets that are invested in a business or other venture
for the general purpose of earning a profit, or a return on the investment.
Generally speaking, the sources of capital for a business are
divided between debt and equity. Debt, as you know, is borrowed money
on which interest is paid. Equity is the broad term for the ownership
capital invested in a business and is most often called owners’ equity.
Owners’ equity arises from two quite different sources: (1) money or
other assets invested in the business by its owners and (2) profit earned
by the business that is retained and not distributed to its owners (called
retained earnings).

## Capital

The investment by a company’s owners in a business, plus the impact of any
accumulated gains or losses.

## Capital

a) Physical capital: buildings, equipment, and any materials used to produce other goods and services in the future rather than being consumed today.
b) Financial capital: funds available for acquiring real capital.
c) Human capital: the value of the education and experience that make people more productive.

## Capital

Expenditures Purchases of productive long-lived assets, in particular, items of property,
plant, and equipment.

## Capital

Any asset or stock of assets, financial or physical, capable of producing income.

## Capital account

Net result of public and private international investment and lending activities.

## Capital Account

That part of the balance of payments accounts that records demands for and supplies of a currency arising from purchases or sales of assets.

## Capital allocation

decision Allocation of invested funds between risk-free assets versus the risky portfolio.

## capital asset

an asset used to generate revenues or cost savings
by providing production, distribution, or service capabilities
for more than one year

## Capital asset

A fixed asset, something that is expected to have long-term usage within
a company, and which exceeds a minimum dollar amount (known as the capitalization
limit, or cap limit).

## Capital asset pricing model (CAPM)

An economic theory that describes the relationship between risk and
expected return, and serves as a model for the pricing of risky securities. The CAPM asserts that the only risk
that is priced by rational investors is systematic risk, because that risk cannot be eliminated by diversification.
The CAPM says that the expected return of a security or a portfolio is equal to the rate on a risk-free security

## Capital Asset Pricing Model (CAPM)

A model for estimating equilibrium rates of return and values of
assets in financial markets; uses beta as a measure of asset risk
relative to market risk

## capital asset pricing model (CAPM)

Theory of the relationship between risk and return which states that the expected risk
premium on any security equals its beta times the market risk premium.

## Capital budget

A firm's set of planned capital expenditures.

## capital budget

management’s plan for investments in longterm
property, plant, and equipment

## capital budget

List of planned investment projects.

## Capital budgeting

The process of choosing the firm's long-term capital assets.

## capital budgeting

Refers generally to analysis procedures for ranking
investments, given a limited amount of total capital that has to be allocated
among the various capital investment opportunities of a business.
The term sometimes is used interchangeably with the analysis techniques
themselves, such as calculating present value, net present value,
and the internal rate of return of investments.

## Capital Budgeting

The process of ranking and selecting investment alternatives and
capital expenditures

## capital budgeting

a process of evaluating an entity’s proposed
long-range projects or courses of future activity for
the purpose of allocating limited resources to desirable
projects

## Capital budgeting

The series of steps one follows when justifying the decision to purchase
an asset, usually including an analysis of costs and related benefits, which
should include a discounted cash flow analysis of the stream of all future cash flows
resulting from the purchase of the asset.

## capital budgeting decision

Decision as to which real assets the firm should acquire.

## Capital Consumption Allowance

See depreciation.

## Capital Cost Allowance (CCA)

The annual depreciation expense allowed by the Canadian Income Tax Act.

## Capital employed

The total of debt and equity, i.e. the total funds in the business.

## Capital expenditures

Amount used during a particular period to acquire or improve long-term assets such as
property, plant or equipment.

## capital expenditures

Refers to investments by a business in long-term
operating assets, including land and buildings, heavy machinery and
equipment, vehicles, tools, and other economic resources used in the
operations of a business. The term capital is used to emphasize that
these are relatively large amounts and that a business has to raise capital
for these expenditures from debt and equity sources.

## Capital flight

The transfer of capital abroad in response to fears of political risk.

## Capital Flows

Purchase by foreigners of our assets (capital inflows) or our purchase of foreign assets (capital outflows).

## Capital gain

When a stock is sold for a profit, it's the difference between the net sales price of securities and
their net cost, or original basis. If a stock is sold below cost, the difference is a capital loss.

## Capital gain

The gain recognized on the sale of a capital item (fixed asset), calculated
by subtracting its sale price from its original purchase price (less the impact of any
associated depreciation).

## Capital Gain

An increase in the value of an asset.

## capital gain

The positive difference between the adjusted cost base of an investment held as a capital property and the proceeds of disposition you receive when you sell it. When you sell such an investment for more than you paid, you realize a capital gain.

## Capital gains yield

The price change portion of a stock's return.

## CAPITAL IN EXCESS OF PAR VALUE

What a company collected when it sold stock for more than the par value per share.

## Capital in excess par

Amounts in excess of the par value or stated value that have been paid by the public to acquire stock in the company; synonymous with additional paid-in capital.

## Capital Investments

Money used to purchase fixed assets for a business, such as land, buildings, or machinery. Also, money invested in a business on the understanding that it will be used to purchase permanent assets rather than to cover day-to-day operating expenses.

## Capital lease

A lease obligation that has to be capitalized on the balance sheet.

## Capital lease

A lease in which the lessee obtains some ownership rights over the asset
involved in the transaction, resulting in the recording of the asset as company property
on its general ledger.

## Capital Lease

One where substantially all of the benefits and risks of ownership are transferred to the lessee. It must be reflected on the company's balance sheet as an asset and corresponding liability.

## Capital loss

The difference between the net cost of a security and the net sale price, if that security is sold at a loss.

## capital loss

The negative difference between the adjusted cost base of an investment held as a capital property and the proceeds of disposition you receive when you sell it. When you sell such an investment for less than you paid, you incur a capital loss.

## Capital market

The market for trading long-term debt instruments (those that mature in more than one year).

## Capital market

The market in which investors buy and sell shares of companies, normally associated with a Stock Exchange.

## Capital Market

A market that specializes in trading long-term, relatively high risk
securities

## Capital Market

The market in which savings are made available to those needing funds to undertake investment projects. A financial market in which longer-term (maturity greater than one year) bonds and stocks are traded.

## Capital market efficiency

Reflects the relative amount of wealth wasted in making transactions. An efficient
capital market allows the transfer of assets with little wealth loss. See: efficient market hypothesis.

## Capital market imperfections view

The view that issuing debt is generally valuable but that the firm's
optimal choice of capital structure is a dynamic process that involves the other views of capital structure (net
corporate/personal tax, agency cost, bankruptcy cost, and pecking order), which result from considerations of
asymmetric information, asymmetric taxes, and transaction costs.

## Capital market line (CML)

The line defined by every combination of the risk-free asset and the market portfolio.

## capital markets

Markets for long-term financing.

## Capital Mobility

A situation in which assets can easily be purchased by foreigners.

## Capital rationing

Placing one or more limits on the amount of new investment undertaken by a firm, either
by using a higher cost of capital, or by setting a maximum on parts of, and/or the entirety of, the capital
budget.

## capital rationing

a condition that exists when there is an
upper-dollar constraint on the amount of capital available
to commit to capital asset acquisition

## capital rationing

Limit set on the amount of funds available for investment.

## capital stock

corporation may issue more than one class of capital stock shares.
One class may give voting privileges in the election of the directors of the
corporation while the other class does not. One class (called preferred
stock) may entitle a certain amount of dividends per share before cash
dividends can be paid on the other class (usually called common stock).
Stock shares may have a minimum value at which they have to be issued
(called the par value), or stock shares can be issued for any amount
(called no-par stock). Stock shares may be traded on public markets such
as the New York Stock Exchange or over the Nasdaq network. There are
on this number). In this regard, I find it very interesting that there are
more than 8,000 mutual funds that invest in stocks.

## Capital Stock

The total amount of plant, equipment, and other physical capital.

## Capital structure

The makeup of the liabilities and stockholders' equity side of the balance sheet, especially
the ratio of debt to equity and the mixture of short and long maturities.

## Capital Structure

The combination of debt, preferred stock, and common stock used
by a company to provide capital for the purchase of its fixed
assets

## capital structure

Firm’s mix of long-term financing.

## Capital Structure

The mix of the various types of debt and equity capital maintained by a firm. The more debt capital a firm has in its capital structure, the more highly leveraged the firm is considered to be.

## capital structure, or capitalization

Terms that refer to the combination of
capital sources that a business has tapped for investing in its assets—in
particular, the mix of its interest-bearing debt and its owners’ equity. In a
more sweeping sense, the terms also include appendages and other features
of the basic debt and equity instruments of a business. Such things
as stock options, stock warrants, and convertible features of preferred
stock and notes payable are included in the more inclusive sense of the
terms, as well as any debt-based and equity-based financial derivatives

## Capital surplus

Amounts of directly contributed equity capital in excess of the par value.

## Capitalism

An economic system in which the marketplace, through the pricing mechanism, determines the allocation and distribution of scarce goods and services, with a minimum of government involvement.

## Capitalization

The debt and/or equity mix that fund a firm's assets.

## Capitalization

The total amount of debt and equity issued by a company.

## Capitalization method

A method of constructing a replicating portfolio in which the manager purchases a
number of the largest-capitalized names in the index stock in proportion to their capitalization.

## capitalization of costs

When a cost is recorded originally as an increase
to an asset account, it is said to be capitalized. This means that the outlay
is treated as a capital expenditure, which becomes part of the total
cost basis of the asset. The alternative is to record the cost as an expense
immediately in the period the cost is incurred. capitalized costs refer
mainly to costs that are recorded in the long-term operating assets of a
business, such as buildings, machines, equipment, tools, and so on.

## Capitalization Rate

A discount rate used to find the present value of a series of future cash receipts. Sometimes called discount rate.

## Capitalization ratios

Also called financial leverage ratios, these ratios compare debt to total capitalization
and thus reflect the extent to which a corporation is trading on its equity. capitalization ratios can be
interpreted only in the context of the stability of industry and company earnings and cash flow.

## Capitalization table

A table showing the capitalization of a firm, which typically includes the amount of
capital obtained from each source - long-term debt and common equity - and the respective capitalization
ratios.

## Capitalize

To make a payment that might otherwise be an expense (in the Profit and Loss account) an asset
(in the Balance Sheet).

## Capitalize

A purchase that has been recorded on the company books as an asset. The
grounds for capitalizing an item include a purchase price that is higher than a minimum
limit (known as the capitalization limit) and an estimated lifetime for the item
that will exceed one year.

## Capitalize

To report an expenditure or accrual as an asset as opposed to expensing it and
charging it against earnings currently.

## Capitalize

In Finance: to find the present value of a stream of cash flows.
In Accounting: to reflect costs of the balance sheet rather than charge them off through the income statement, as to capitalize major repairs to a fixed asset.

## Capitalized

Recorded in asset accounts and then depreciated or amortized, as is appropriate for expenditures
for items with useful lives greater than one year.

## Capitalized Cost An expenditure or accrual that is reported as an asset to be amortized against

future-period revenue.

## Capitalized Expenditures

Expenditures that are accounted for as assets to be amortized
against income in future periods as opposed to current-period expenses.

## Capitalized interest

Interest that is not immediately expensed, but rather is considered as an asset and is then
amortized through the income statement over time.

## Capitalized Interest

Interest incurred during the construction period on monies invested in
assets under construction that is added to the cost of the assets.