Types of Capital Investment Projects

A new capital investment project is important for the growth and expansion of a company. It is also important for the economy at large as it often leads to research and development. This type of project is one that is either for expansion into a new product line or a new product market, often called the target market.

A new product or a new target market could, conceivably, change the nature of the business. It should be approved by higher-ups in the business organization. A new project, either a new product or a new target market, requires a detailed financial analysis and the approval of possibly even the firm's Board of Directors.

An example of a new product would be a new medical device that is conceived, researched, and developed by a company specializing in medical devices. Perhaps this medical device would tap into a target market that the company had not yet been able to reach.

The expansion of existing products or target markets means an expansion of the business. If a company undertakes this kind of capital budgeting product, they are effectively acknowledging a surge in growth of demand.

A detailed financial analysis is required, but not as detailed as that required for the expansion of the company into new products or new target markets.

An example of a replacement project necessary to continue usual operations would be funding the replacement of a worn-out piece of equipment with a new piece designed to do the same job in a manufacturing plant.

It is a simple capital budgeting project to evaluate. It would be possible to use one of these simpler capital budgeting methods to evaluate this project and abide by the decision of the capital budgeting method.

The cash flows from a replacement project necessary to continue operations, as usual, are fairly easy to estimate, at least compared to other types of projects, because the business owner is replacing the same type of equipment and is, therefore, somewhat familiar with it.

During the Great Recession, many companies have been looking at this type of capital project. Sometimes, businesses need to replace some projects with others to reduce costs. An example would be replacing a piece of obsolete equipment with a more modern piece of equipment that is easier to have serviced.

This type of capital budgeting project would require a detailed financial analysis with cash flows estimated from each piece of equipment to determine which generates the most in cash flows and, thus, saves money. These are the four basic types of capital budgeting projects, although there are offshoots of each one.