Capital budgeting or investment decision is of considerable importance to the firm. Its value by influencing its growth profitability and risk.
The investment decisions of a firm are generally known as the capital budgeting or capital expenditure decision.
A capital budgeting decision defined as the firm’s decision to invest its current funds in the long-term assets. Sale of a division or business(divestment) is also as an investment decision.
Decision like the change in the methods of sales distribution. An advertisement campaign or research and development programme has long-term implication for the firm’s expenditure and benefit. They should evaluated as investment decisions.
Feature of investment decision.
1) The exchange of current funds.
2) The funds are invested in long-term assets
3) The future benefit will occure to the firm over a series of a year.
Types of investment decision
There are many ways to classify investment
1)Expansion and diversification: -A company may add capacity to its existing product lines to expand an existing operation. A firm may expand its activities in a new business requires investment in new products. A new kind of production activity within firm.
Sometimes a company acquires existing firms to expand its business. The investment in the expectation of additional revenue. Investment in existing or new products may also be called revenue expansion investment.
2)Replacement and modernization:-The main objective of modernisation and replacement is to improve of operating efficiency and reduce cost. Cost savings will reflect on the increased profits, but the firm’s revenue may remain unchanged.
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.Replacement decision help to introduce more efficient and economical assets. It also called cost-reduction investments.
3)Mutually exclusive investment:-Mutually exclusive investment serve the same purpose and compete with each other. If one investment is undertaken, others will have to exclude. A Company may, for example, either use a more labour-intensive, semi-automatic machine, for production. Choosing the semi-automatic machine precludes the acceptance of the highly automatic machine.
4)Independent investments:-Independent investment serve a different purpose and do not compare with each other. For example, a heavy engineering company may be considering expansion of its plant capacity Company wants to manufacture additional excavators. Addition of new production facilities to manufacture a new product-light commercial vehicles.
5) Contingent investment:-Contingent investment are dependent projects the choice of one investment undertaking one or more other investment.If a company decide to build a factory in a remote, backward area. It may have to invest in houses, roads, hospitals, school etc. The building of the factory also requires investment in facilities for employees. The total expenditure treated as one single investment.
Important of Investment decisions
1)Growth:-The effects of investment decisions extend into the future and have to endure for a longer period. The consequences of the current operating expenditure. A firm’s decision to invest in long-term assets has a decisive influence on the rate and direction of its growth.
A wrong decision can prove disastrous for the continued survival of the firm unwanted or unprofitable expansion of assets. It will result in heavy operating costs to the firm.
2)Risk:-A long-term commitment of funds may also change the risk complexity of the firm.If the adoption of an investment increases average gain but causes frequent fluctuation in its earnings.
3)Funding:-Investment decisions generally involve a large amount of funds. Its make it imperative for the firm to plan its investment programmes very carefully . It makes an advance arrangment for procuring finances internally or externally.
4)Irreversibility:-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.
5)Complexity:-Investment decisions are among the firm’s most difficult decisions. They are an assessment of future events which are difficult to predict. It is a really complex problem to correctly estimate the future cash flows of an investment. Economic, political, social and technological forces cause the uncertainity in cash flow estimation.