We’ve examined a number of short-term decision making – accept a special order, make or buy a component, and keep or drop a product. We also know that in making these decisions – we need to consider capacity constraints, relevant revenues and costs, identify any avoidable or unavoidable costs, consider the sunk costs and evaluate whether there are any opportunity costs. However, we have not discussed what might happen if we want to consider INCREASING the capacity of the business.
This sort of decision is a longer-term one in which the business is likely to need to spend larger amounts of funds – either from cash previously saved, or obtained from a bank loan or increasing shareholder investment in the business. Business will need to look into the future (often far into the future – periods like 5, 10 and 15 years) and make predictions about potential revenues and costs (remember our budgeting chapter – but over a longer time frame) and determine whether the investment will be worth it.
The technique used to make this type of decision is Net Present Value – determining the value of future cash outflows and inflows that arise from the investment taking into account the cost of borrowing and inflation. This content will usually be covered in an introductory finance subject in business/commerce programs. To find out more – read up on the Investopedia website on NPV.