Capital Investment Decisions

HCS/385

8/28/2019

Capital Investment Decisions

One factor that is crucial to the success of a business is having the ability to make good choices when it comes to capital investment decisions. Understanding what capital investments are and their objectives is the first step to achieving this goal. Also, knowing how the amount of funds available affect choices, and the role that the cost of capital plays in the capital investment decision-making process are all factors that help a business achieve success.

What are Capital Investments?

Capital investment decisions are being among the most important decisions made by an organization. Capital investments refer to furthering an organization’s objectives with the process of investing funds. For any organization this entails multiple funding options with a variety of differing rates. A capital investment decision is one that involves a high value investment that can assist in achieving benefits for an organization long term (Zelman, McCue, & Glick, 2014). Various sources of capital investments may consist of financial institutions, banks, venture capital along with angel and/or equity investors. Capital investments are generally long-term assets, however a portion of it may be applied for purposes of working capital. There are a few distinct types of capital decisions that are made in accordance with the specific situation. They are expansion decisions, strategic decisions, and replacements decisions. An expansion decision is one that is designed to increase the capabilities of an organization through their operations and functions. Strategic decisions are those designed to increase an organization’s strategic position. A replacement decision is one that is intended to use new assets that cut costs to replace the older assets. In addition to the different forms on capital investment decisions, there are two major components in capital investment decisions, and those are to determine if the investment will be a valuable one, and determining the financial path for the investment (Zelman, McCue, & Glick, 2014).

The Objectives of Capital Investments

Seeing as how capital investments are funds invested in to an organization to further its business aspirations, the major objective is that these funds can increase assets and increase the organization’s overall position. The main purpose of investing is to obtain a positive net present value (NPV). It is important to realize that one of the most crucial attributes for a company to remain competitive is associated with capital investments. It is important that investments have long-term implications for the business’ in their period of earnings for current returns and returns in the future (Bhattacharya & Wheatley, Spring 2006). It is the managements objective to assess potential investments and determine whether they will result in profit or loss. This is the process of capital investment analysis. Management analyzes capital investment decisions and evaluate the organization’s liquidity. This is performed to determine whether enough funds exist within the company to invest. It is also an important objective to analyze and determine the payback period, which refers to the time it takes to gain return on an investment. The formula used when calculating the payback period is: The Amount to be Invested / Annual Net Cash Flow = Payback Period (Zelman, McCue, & Glick, 2014).

There are many factors and objectives that need to be considered before a company makes an investment. A thorough dissect and analysis of the company’s finances and the potential investments are key to making the right investment decisions. Bakke, (2016), quotes Benjamin Franklin in saying that “an investment in knowledge pays the best interest.” He describes the main objective to obtain when choosing to invest as nothing paying off more than the act of educating yourself. It is important to do the research needed, study the information, and analyze all factors before making any decisions on capital investments.

Investment decisions are those made by management on behalf of the investors. The decisions made primarily regard the best interest of its investors as the amount of funds to be awarded of the investment opportunity. This is completed by selecting the type of assets in which the cash will be invested by the company’s investment team.

How the Amount of Funds Available Affect Choices on Capital Investment Decisions

Capital investment is also viewed and handled as capital budgeting. When decisions are being made, they are aiming to include an effective manner to ensure the best possible returns overall. This will affect the choices being made. Firms must look at everything as a positive and negative and the project at hand. The allocation of the capital will determine the requirements needed, and this is the crucial capital investments decisions views. The investment decisions of all projects in which they are ranked play a crucial part in the decisions being made with the capital investments. (Capital-Investment.co.uk, n.d.).

The amount of funds available will require the firm to study the possible investment and if it will permit them to make certain the resources are in line. The target and main goal of all businesses, in the event of making decisions, is to help maximize the wealth of shareholders. As the owner, you can retrieve and decide which of the project investment would bring in a greater cash flow. Most importantly, it is important to keep in mind that decisions are generally controlled by completing the process of rating and observing the capital investment decisions made by the. If appropriate factors are not considered regarding how the amount of funds may affect choices may result in an investment suffering a great deal. (Investopedia, 2017).

The Capital investment decisions directly corelate to the success of any company. The decisions made are evaluated by the company’s stakeholders. The current financial state of the organization will be analyzed and choices will be generated about how their investments may be affected. The analysis and data they review provides them with the information (such as funds available) to make strategic decision. The capital investment decisions will allow them to invest in products and/or technology to help their organization grow. For example, when planning for their yearly budget they will plan to budget for computers to function better – this type of decision needs the necessary data to make and the funds. This will allow them to better their profits in the future and possibly make them more competitive. If there are other organization like them around them but they have better products/technology than they are being left behind which is why making the capital investment decision will help them stand out. Essentially, they will benefit in the long term with any capital investment decision that is made. For a company to be successful one should take those risks and make those investments; which again, cannot happen unless all stakeholders are on board and agree to this once the financial data is reviewed.

How the Cost of Capital is a Factor in the Decision-Making Process

The cost of capital as it pertains to a business is a very important and thought out decision, a process even. The first step is to analyze the type of business that is seeking funding or financing as a preliminary factor. The overall cost is going to be dictated by the mode of financing that the business uses. Some common modes are financing by lending, trade related modes, and the purchase of trade bills and financing based on profit sharing. Finance by lending are loans that aren’t carrying any interest, and in that case, the bank can recover a service charge if it does not exceed the usual cost of the procedure, not including the cost of funds and making room for poor and uncertain debts. Trade-related modes are the purchase of goods or services by banks or institutions and selling to clients at an alternate cost that usually includes an appropriate markup of the price based on a deferred payment. Purchase of trade bills and financing based on profit sharing equates to the purchase of commodities from a financial institute. It is then sold to clients however, the price is marked up which is based on deferred payments (Cleverism,2017).

There are several factors how the cost of capital is determined. They are like those of an individual trying to obtain credit. Some of the same factors are taken into consideration for businesses, such as operating history credit worthiness profitability, and profitability potential. At the end of the day, organizations and shareholders want to know that the business in question is in good standing. If there is no money to be made, then there is are no benefits for anyone.

Conclusion

Making good capital investment decisions in one of the most crucial decisions a business can make. It is vital for an organization to have a full understanding of what capital investments are, their objectives and the roles they play in the choices that a business must make to achieve their goals. Capital investment decisions are affected by the funding available as well as the cost of the capital and are both large factors in the decision-making processes made by an organization to lead them on a path of financial success.

References

Bakke, D. (2016, 11 30). Top 17 Investing Quotes of All Time. Retrieved from

Investopedia: http://www.investopedia.com/financial-edge/0511/the-top-17-investing-quotes-of-all-time.aspx

Bhattacharya, M., & Wheatley, K. K. (Spring 2006). Organizational Risk and Capital

Investments: A Longitudinal Examination of Performance Effects and Moderating Contexts. Journal of Managerial Issues: JMI; Pittsburg18.1, 62 – 83,8.

Capital-Investment.co.uk. (n.d.). Capital Investment Decisions. Retrieved from

http://www.capital-investment.co.uk/capital-investment-decisions.php

Cleverism. (2017). How to Calculate the Cost of Capital for Your Business. Retrieved

from https://www.cleverism.com/calculate-cost-capital-business/

 Investopedia. (2017). Factors Affecting the Cost of Capital. Retrieved from

http://www.investopedia.com/exam-guide/cfa-level-1/corporate-finance/factors-affecting-cost-of-capital.asp

Zelman, W. N., McCue, M. J., & Glick, N. D. (2014). Financial Management of Health

Care Organizations: An Introduction to Fundamental Tools, Concepts, and Applications (4th ed.). San Francisco, CA: Jossey- Bass