Financial and Strategic Management

What is Investment Decisions?

The investment decision is the most important decision for value creation. Investment ordinarily means the utilization of money for profits or returns. This could be done by creating physical assets with the money and carrying on business or purchasing shares or debentures of a company. Investments necessarily involve uncertainty and are therefore necessarily risky. Within a firm, a finance manager decides that in which activity resources of the firm are to be channelized. A marketing manager may like to have a new showroom, a production manager a new lathe and a personnel manager higher wages for labour, which may lead to regular and efficient production. Over and above, the top management may like to enter an entirely new area of production like a textile company entering electronics. These are the ventures which are likely to increase profits. But resources are limited. Hence, the problem of accepting one proposal and leaving the other persists. All investment proposals have to be evaluated in relation to
expected return and risk.

Investment decisions and capital budgeting are considered synonymous in the business world. Investment decisions are concerned with the question of whether adding to capital assets today will increase the revenue of tomorrow to cover costs. Thus investment decisions are commitments of monetary resources at different times in expectation of economic returns in the future. The choice is required to be made amongst available resources and avenues for investment. As such investment decisions are concerned with the choice of acquiring real assets, over the time period, in a productive process. In making such a choice consideration of certain aspects is essential viz., need for investment, factors affecting decisions, risk-return criteria for evaluating investment decisions, and selection of a particular alternative from amongst the various options available.

Investment decisions have, thus, become the most important area in the decision-making process of a company. Such decisions are essentially made after evaluating the different proposals with reference to the growth and profitability projections of the company. The choice helps achieve the long-term objectives of the company i.e., survival and growth, preserving a market share of its products and retaining leadership in its production activity.

The company likes to avail of the economic opportunity for which investment decisions are taken viz.,

(1) Expansion of the production process to meet the existing excessive demand in the local market, exploit the global market, and to avail of the advantages and economies of the expanded scale of production.

(2) Replacement of an existing asset, plant, and machinery or building, necessary for taking advantages of technological innovations, minimising the cost of production by replacing obsolete and worn out plants, increasing efficiency of labour, etc.

(3) The choice of equipment establishes the need for investment decisions based on the question of quality and the latest technology.

(4) Re-allocation of capital is another area of investment, to ensure asset allocation in tune with the production policy.

(5) Mergers acquisitions, re-organizations and rehabilitation are all concerned with economic and financial involvement and are governed by investment decisions.

Thus, investment decisions encompass wide and complex matters involving the following areas:
  – capital budgeting
  – cost of capital
  – measuring risk
  – management of liquidity and current assets
  – expansion and contraction involving business failure and re-organizations
  – buy or hire or lease an asset.

Factors affecting investment decisions are essentially the ingredients of investment decisions. Capital is a scarce resource and its supply cost is very high. Optimal investment decisions need to be made taking into consideration such factors as are given below viz.

(1)  Estimation of capital outlays and the future earnings of
the proposed project focusing on the task of value engineering and market forecasting;

2) Availability of capital and considerations of cost of capital focusing attention on financial analysis; and

(3) A set of standards by which to select a project for implementation and maximizing returns therefrom focusing attention on logic and arithmetic.

About the author

Shreya Kushwaha

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