Capital Investment Decisions
Capital investment decisions also can be called ‘capital budgeting’ in financial terms. Capital investment decisions aim includes allotting the capital investment funds of the firm in the most effective manner to make sure that the returns are the best possible returns. Assessing projects as well as the allocation of the capital depends on the project requirements are some of the most crucial capital investment decisions aspects.
There might be many different criteria’s for choosing the appropriate and right capital investment decision. For e.g., a company might stress on projects that assure for prompt returns while a few other companies might assert on projects which ensure for a growth in the long term. The important aim of capital investment decision is increasing the firms’ value by taking on a good project at the perfect time.
The power to study as well as take capital investment decisions permits an individual as the manager or owner of a particular business to make sure that their resources which are limited are apportioned to the project(s) which would best accomplish their strategical goals (thus they also are at times denoted as strategic capital investment decisions). These kinds of decisions could be associated to capital investments decisions like constructing a new factory, dedication towards a new campaign for marketing, acquiring a business or developing or creating a new website.
The aim of a business while making capital investment decisions is maximising the wealth of the shareholder by acquiring assets and yielding profit and to be able to do this, as the owner of your business, you should to be able to find out and determine as to what projects of capital investment would yield a cash flow which is positive and when there are constrained resources, as they generally are in case of start-up or small business or usually for most of the businesses that are facing the credit-crunch, rate the projects in the bases of priority depending on the kind of value they generate.
Capital investment decisions mostly are regulated by the procedure of rating and identifying the organization's capital investments. The company ought to decide as to which of the capital investments that are given, would ensure the maximum value to their business and thus they can make their capital investment decision.
The capital investment decisions suffer from a many constraints generally. The sum of capital which an organization collects is restricted and thus it gets the restraint on the firms’ choice down to an extent, over several project investments. When the firms’ debt is raised, the firms’ debt-equity ratio too is increased and thus it gets hard for a business to be able to increase more debts.
Making strategic capital investment decisions which are consistent could also be problematic because a lot of people prefer using capital investment appraisal techniques which increases the chances of having their favourite projects accepted. In a lot of cases, capital investment decisions are reached subjectively and financial technics are put in to use to rationalize, once the capital investment decision has been made.
Most of the investment projects which are strategic have problems which are ill-structured, calling for an approach which might never have been ever put to use before, thus, complexity, novelty, irreversibility and ambiguity characterise these capital investment decision projects. It’s important that we recognise thus and put the strategies in place to deal with such issues and problems because if you make one wrong capital investment decision, then it can impact a business’s value negatively thereby making creditors and investors not really willing or keen to fund the business any time in future.
The capital investment decision of project ranking plays a crucial role in capital investment decisions. Depending upon the kind of project a firm has at a particular point of time, the companies prioritize the various projects. Project ranking is dependant on the fact as to how much would a particular project return as well as which project has the ability to provide the business, a maximum value.
There are a lot of measures which give an estimate of the firms’ return over several investment projects. To be able to determine a specific projects’ value, the three most common used methods are - payback method, net present value method, and the IRR methods. These are the different kind of methods which are put to use while taking capital investment decisions.
The process of making a capital investment decision involves these steps:
- Identification of a project
- Definition of a project and screening
- Analysing and accepting
- Post audit
In practice actually, a lot of capital investment decisions are reached with specified time period and information generally leaving out one or more than one steps in capital investment making process. The political activity inside an organization might also effect a capital investment decision, where individuals or groups have a set interest in certain projects.
The capital investment decisions aren’t regularized by 1 or 2 components or factor because the problem of investment is not just one of the problems of substituting old equipment with new, but it’s related to replacing an existent procedure within a system with a new one that makes the whole system better and much more effective. These are some of the factors which affect capital investment decisions:
- The outlook of the management
- Opportunities which are created by technological changes
- Strategy of the competitor
- Cash flow budget
- Fiscal Incentives
- Market Forecast
- Other non-economic factors
These motives would explain clearly as to why capital investment decisions are extremely important for an organization:
- Expansion: Capital investment decisions are aimed at the expansion of operation levels. It’s achieved through acquiring fixed assets by buying plant facilities and property, which ensure a good investment and capital investment balancing in turn.
- Replacement: Post the period of maturity, when the growth of a firm slows down, the firms; worn out or outdated assets need to be replaced, like machinery, vehicles, equipment, etc. Hence, an organization can turn back to its production full-flegedly and yield the desired benefits.
- Renewal: As a substitute to replacing, renewal might involve rebuilding, retrofitting or overhauling an existent asset. This definitely increases the firms’ profits and productions.