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Investment Decisions

Investment decisions of a firm are generally known as the capital budgeting, or capital expenditure decision. It is defined as the firm decision to invest its current funds most efficiently in the long-term assets in anticipation of an expected flow of benefits over a series of years (the long-term assets are those that affects the firms operations beyond the one-year period) it includes expansion, acquisition, modernization and replacement of the long-term assets, sale of a division or business(divestment), change in the methods of sales distribution, an advertisement campaign, research and development programme and employee training, shares (tangible and intangible assets that create value). .According to Experts, investment decisions is decisions that influence a firms growth in the long-term, affect the risk of the firm, involve commitment of large amount of funds, are irreversible or reversible at substantial loss, and among the most difficult decisions to make. Horne, define investment decisions as the allocation of capital to investment proposal whose benefits are to be realized in the future and includes, new product or expansion of existing products, replacement of equipment or buildings, research and development, exploration and others.

Objectives of Investment decision in Business:The fundamental objectives of all business decisions is to maximize the return on stock holders equity, there are others factor shaping effective capital allocation strategies and tactics. Financial management, therefore, can be effective only if it is based on well formulated multiple goals and objectives, for a profit making organization, the primary objective may be to maximize the value of shareholders wealth, to maximize the total resources, or to maximize owner equity over the long run.

Importance Of Investment Decisions


Investment decisions require special attention because of the following reasons: 1. They influence the firms growth in the long run,

2. They affect the risk of the firm, 3. They involve commitment of large amount of funds, 4. They are irreversible, or reversible at substantial loss, 5. They are among the most difficult decisions to make

Growth:
The effect of investment decisions extend into the future and have to be endured for a longer period than the consequences of the current operating expenditure. A firms decision to invest in long term asset has a decisive influence on the rate and direction of growth. A wrong decision can prove disastrous for the continued survival of the firm; unwanted or unprofitable expansion of asset will result in heavy operating costs to the firm. On the other hand, inadequate investment in asset would make it difficult for the firm to compete successfully and maintain its market share.

Risk:
A long-term commitment of fund may also change the risk complexity of the firm. If the adoption of an investment increase average gain but causes frequent fluctuations in its earnings, the firm will become more risky. Thus, investment decisions shape the basic character of a firm.

Funding:
Investment decisions generally involve large amount of funds, which make it imperative for the firm to plan its investment programmes very carefully and make advance arrangement for procuring finances internally and externally.

Irreversible:
Most investment decisions are irreversible. It is difficult to find a market for such capital items once they have been acquired. The firm will incur heavy losses if such assets are scrapped

Complexity:
Investment decisions are among the firms most difficult decisions. They are an assessment of future events, which are difficult to predict. It is really a complex problem to correctly estimate the future cash flows of an investment. Economic, political, social and technology forces cause the uncertainty in cash flow estimation.

Factors influencing investment decision


Capital investment decisions are not governed by one or two factors, because the investment problem is not simply one of replacing old equipment by a new one, but is concerned with replacing an existing process in a system with another process which makes the entire system more effective. We discuss below some of the relevant factors that affects investment decisions:

Management Outlook:
If the management is progressive and has an aggressively marketing and growth outlook, it will encourage innovation and favor capital proposals which ensure better productivity on quality or both. In some industries where the product being manufactured is a simple standardized one, innovation is difficult and management would be extremely cost conscious. In contrast, in industries such as chemicals and electronics, a firm cannot survive, if it follows a policy of 'make-do' with its existing equipment. The management has to be progressive and innovation must be encouraged in such cases.

Competitors Strategy:
Competitors' strategy regarding capital investment exerts significant influence on the investment decision of a company. If competitors continue to install more equipment and succeed in turning out better products, the existence of the company not following suit would be seriously threatened. This reaction to a rival's policy regarding capital investment often

forces decision on a company'

Opportunities created by technological change:


Technological changes create new equipment which may represent a major change in process, so that there emerges the need for re-evaluation of existing capital equipment in a company. Some changes may justify new investments. Sometimes the old equipment which has to be replaced by new equipment as a result of technical innovation may be downgraded to some other applications, A proper evaluation of this aspect is necessary, but is often not given due consideration. In this connection, we may note that the cost of new equipment is a major factor in investment decisions. However the management should think in terms of incremental cost, not the full accounting cost of the new equipment because cost of new equipment is partly offset by the salvage value of the replaced equipment. In such analysis an index called the disposal ratio becomes relevant. Disposal ratio = (Salvage value, Alternative use value) / Installed cost

Market forecast: Both short and long run market forecasts are influential factors in capital investment decisions. In order to participate in long-run forecast for market potential critical decisions on capital investment have to be taken.

Fiscal Incentives: Tax concessions either on new investment incomes or investment allowance allowed on new investment decisions, the method for allowing depreciation deduction allowance also influence new investment decisions.

Cash flow Budget: The analysis of cash-flow budget which shows the flow of funds into and out of the company may affect capital investment decision in two ways. 'First, the analysis may indicate that a company may acquire necessary cash to purchase the equipment not immediately but after say, one year, or it may show that the purchase of capital assets now may generate the demand for major capital additions after two years and such expenditure might clash with anticipated other expenditures which cannot be postponed. Secondly, the cash flow budget shows the timing of cash flows for alternative investments and thus helps management in selecting the desired investment project.

Non-economic factors: New equipment may make the workshop a pleasant place and permit more socializing on the job. The effect would be reduced absenteeism and increased productivity. It may be difficult to evaluate the benefits in monetary terms and as such we call this as non-economic factor. Let us take one more example. Suppose the installation of a new machine ensures greater safety in operation. It is difficult to measure the resulting monetary saving through avoidance of an unknown number of injuries. Even then, these factors give tangible results and do influence investment decisions. Investment Decisions Types There are many ways to classify investment. One classification is as follows: Expansion of existing business Expansion of new business Replacement and modernization.

Expansion and diversification


A company may add capacity to its existing product lines to expand existing operations. For example, the Gujarat state fertilizer company (GSFC) may increase its plant capacity to manufacture more urea. It is an example of related diversification. A firm may expand its activities in a new business. Expansion of a new business requires investment in new products and a new kind of production activity within the firm. If a packaging manufacturing company invests in a new plant and machinery to produce ball bearing, which the firm has not manufactured before, this represents expansion of new business or unrelated diversification. Sometimes a company acquires existing firms to expand its business. In either case, the firm makes investment in the expectation of additional revenue. Investments in existing or new products may also be called as revenue-expansion investments.

Replacement and modernization


The main adjective of modernization and replacement is to improve operating efficiency and reduce costs, cost savings will reflect in the increased profits, but the firms revenues may remain unchanged. Assets become outdated and obsolete with technological changes. The firm must decide to replace those assets with new assets that operate more economically. If a cement company changes from semi-automatic drying equipment to fully automatic drying equipment, it is an example of modernization and replacement. Replacement decisions help to introduce more efficient and economical assets and therefore, are also called cost-reduction investments however; replacement decisions that involve substantial modernization and technological improvement expand revenues as well as reduce costs.

Conclusion:Globalization, accompanied by open trade and investment, provides the conditions for improved economic prosperity as well as environmental protection. Business continues to be an important and engaged actor in the pursuit of sustainable development, and in partnership with others, can make its contribution most effectively in the framework of economic growth, more open trade and investment and a conducive regulatory framework. Capital investment decisions are long-term corporate f i n a n c e d e c i s i o n s r e l a t i n g t o fixed assets and capital structure. Decisions are based on several inter-related criteria. Corporate management seeks to maximize the value of the firm by investing in projects which yield appositive net present value. W h e n v a l u e d u s i n g a n appropriate discount rate. These projects must also be financed appropriately. If no such opportunities exist, maximizing shareholders value dictates that management returns excess cash to shareholders. Capital investment decisions thus compromise an investment decision, a financial decision, and a dividend decisions. A p o s i t i v e i n v e s t m e n t d e c i s i o n c a n only be taken the application of ratio analysis.