The manager and the board will probably have more capital proposals than they have cash to fund them; so, some methods are required for choosing the most appropriate ones ...
Capital Investment Decisions
Part of a turfgrass manager’s role is to propose one or more capital expenditure projects that would benefit the facility. These projects will then be proposed to the management board, typically as a part of the budgeting process. The manager and the board will probably have more capital proposals than they have cash to fund them; so, some methods are required for choosing the most appropriate ones, whether machinery, course improvements or clubhouse investment.
Some typical capital investment decisions facing the enterprise from time to time include:
1. Replace or repair/keep? As equipment or facilities become nearly “used up” the decision must be made about whether to repair them and use them longer or replace them with new items. Generally, the older these items are, the more costly the ongoing maintenance.
2. Purchase capital item A or B? When buying a new machine, the enterprise usually has a choice among different brands, sizes, performance characteristics etc. Whilst much of the decision can be based on technical differences, a major consideration has to be the economic differences between competing proposals.
3. Lease or buy? Sports facilities often have the option to either buy equipment or lease it. Differences in the economics of the two options should be considered.
4. Do it yourself or hire it out? Much maintenance and construction work can either be done by in-house staff or by outside contractors. Economic differences often can be the deciding factor.
These capital investment decisions occur occasionally throughout the year, rather than as daily operating decisions. Ideally, the manager anticipates these major changes and carefully plans for them.
Investment Appraisal Methods
There are several different methods of investment appraisal, however the three main ones are:
TABLE 1 Years 1 + 2 + 3 + 4
1. Payback 2. Annual return 3. Net Present Value
When evaluating investment appraisal methods it should be remembered that all methods rely on the accuracy of predicted net cash flows over the project lifetime, where net cash flow is the difference between the cash received and cash paid during the defined lifetime period. For example, installation of a drainage system should enable a golf course to be open for more days, bringing in extra revenue. When replacing old machinery the cash received is the savings on maintenance and repair costs.
We shall look at how to use the three investment appraisal methods by examining three options a golf club has for spending £40,000 available for improvements. The Course Manager would like to:
1. Replace a fairway mower with a new one
2. Upgrade the irrigation system 3. Install drainage
Each of these options are costing the club money through repair bills and loss of income. However, only one option can be chosen due to the cash restrictions.
1. Payback
Payback is a method that aims to estimate how long it will take for a project to start generating an income. It looks at the value of the initial investment compared to the projected net cash flow.
Having calculated the payback period it may be of interest to calculate the surplus cash generated during the project lifetime, after recouping the initial investment. This surplus cash could be from income generated e.g. from the purchase of golf buggies, or savings on costs e.g. when replacing old machinery.
Example 1 - making course alterations to reduce maintenance time and costs
Calculations from a forecasted maintenance schedule analysis show that, if an initial investment of £40,000 is made for Project A, the following net cash flows (savings in maintenance costs)
= £39,500 (used to recoup investment)
In Year 5 amount needed to recoupinvestment in full = £40,000 -£
£39,500 = £500
Months in Year 5 before investment fully recouped = £500 £12,000 x 12
Net cash flow over 5 year project
Total net cash flow (after payback)
= £51,500 = £51,500 -£ £40,000 = £11,500 89 = 0.49 months
will be generated: Year 1
2 3 4 5
Net Cash Flow 9,000
10,500 10,500 12,000
9,500
The above figures are calculated by estimating the reduction in maintenance costs compared to keeping the course as it is.
To calculate the payback period of the £40,000 investment, total the net cash flow figures over consecutive years until the full investment is recouped (see table 1).
With this example the investment is fully recouped in just over 4 years, resulting in a total net cash flow, after payback, of £11,500 for the 5 year project.
Example 2 - installation of a borehole to replace mains water for irrigation
Project B requires an initial investment of £40,000 and is forecast to yield the following net cash flow figures in water savings:
Year 1
2 3 4 5
Net Cash Flow 5,000
5,000 6,000 6,000 7,000
(See table 2)
With this project, the initial investment would not be recouped after 5 years. This does not preclude the project, as ongoing savings may be deemed worth pressing ahead.
Example 3 - drainage of three fairways that causes regular closure of the course during the winter and loss of green fees.
An initial investment of £40,000 into Project C will lead to the following net cash flows:
Year 1
2 3 4 5
TABLE 2 Years 1 + 2 + 3 + 4 + 5 Throughout 5 year project
Total net cash flow (after payback)
= £29,000 -£
Net Cash Flow (4,000)
13,000 16,500 18,000
(See table 3)
= £29,000 = £29,000
£40,000 = (£11,000) 9,000
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