The Influence of Capital Expenditure

Capital expenditure generally brings in changes in the cost pattern of a product or service. If the capital expenditure is to replace an asset with an identical asset, there will not be much change to the cost pattern. If the capital expenditure results in an enhancement or addition, then the indirect costs or overhead costs of a product or service increase. This increase might be offset by a decrease in variable cost. For example, if manual labor is replaced by machines, then the labor cost goes down but the overhead cost, such as depreciation on the machines, goes up. However, since the changes are aimed at increasing efficiency, the total cost of a unit of product or service is expected to go down.

The increase in the fixed assets may limit the organization’s range of products or service but increase its overall performance. A highly sophisticated machine costs a large sum of money and, because of its specialty, the variety of products it makes may be limited. However, the products from this machine would be cost-effective because of the efficiency of production. A similar effect can be expected when a special machine is used to provide services. A special building will increase the machine efficiency, but it will limit its flexibility for other purposes. Therefore, capital expenditure should be carefully reviewed for the purpose for which it is made and for the long-term plans of the organization, since flexibility reduces the capability of the asset in which investment is made.

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