Investment Decision:

The investment decisions of a firm are generally known as the capital budgeting or capital
expenditure decisions. Investment decisions are made by investors and investment
managers. A capital budgeting decision may be defined as the firms 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 affect the firms operations beyond the one
year period. The firms investment decisions would generally include expansion, acquisition,
modernization and replacement of the long term assets.
Capital budgeting may also be defined as The decision making process by which a firm
evaluates the purchase of major fixed assets. Fixed assets are frequently termed as
earning assets of the firm in the sense that they usually generate large return.
Future sales growth is correlated with expansion of capital expenditure.

The investments should be evaluated on the basis of a criterion, which is compatible with the
objective of the shareholders wealth maximization. An investment will add to the shareholders
wealth if it yields benefits in excess of the minimum benefits as per the opportunity cost of
capital.
The basic features of capital budgeting are:
1. Potentially large anticipated benefits;
2. A relatively high degree of risk and
3. A relatively long time period between initial outlay and anticipated returns.

Importance
Capital budgeting is of paramount importance in financial decision making. Special care should
be taken in making these decisions on account of the following reasons:

1. Such decisions affect the profitability of the firm. They also have bearing on the competitive
position of the enterprise. This is mainly because of the fact that they relate to fixed assets. The
fixed assets represent in a sense, the true earning assets of the firm. They enable the firm to
generate finished goods that can ultimately be sold for a profit. However, current assets are not
generally earning assets. They provide a buffer that allows the firm to make sales and extend
credit. Capital budgeting decisions determine the future destiny of the company. An opportune
investment decision can yield spectacular returns. On the other hand an ill advised and incorrect
investment decision can endanger the very survival even of large sized firms. A few wrong
decisions and a firm can be forced into bankruptcy. Capital budgeting is of utmost importance to
avoid over-investment and under-investment in fixed assets.

2. A capital expenditure decision has its effect over a long time span and inevitably affects the
company's future cost structure. To illustrate, if a particular plan has been purchased by a
company to start a new product, the company commits itself to a sizable amount of fixed assets
in terms of supervisors, salary, insurance, rent of buildings and so on. If the investment in future
turns out to be unsuccessful or yields less profit than anticipated, the firm will have to bear the
burden of fixed costs unless it writes off the investment completely. In short, a firm's future
costs, break-even point, sales and profits will all be determined by the firm's selection of assets
i.e., capital budgeting.

Long term investment decisions are more difficult to take because:

Decision extends to a series of years and beyond the current accounting period;

Uncertainties of future and

Higher degree of risk

3. Capital investment decision once made is not easily reversible without much financial loss to
the firm. It is because there may be no market for second hand plant and equipment and their
conversion to other uses may not be financially feasible.
4. Capital investment involves cost and the majority of the firms have scarce capital resource.
This underlines the need for thoughtful, wise and correct investment decisions as an incorrect
decision would not only result in losses but also prevent the firm from earning profits from other
investments which could not be undertaken for want of funds.
5. Over / under capacity: To improve timing and quality of asset acquisition, the capital
expenditure decision must be carefully drawn. If the firm has invested too much in assets, it will
incur unnecessary heavy expenditure. If it has not spent enough on fixed assets, two serious
problems may arise
(i) The firms equipment may not be sufficiently modern to enable it to produce competitively.
(ii) If it has inadequate capacity it may lose a portion of its share of market to its rival firm. To
regain lost customers it would require heavy selling expenses, price reduction, product
improvement, etc.
6. Investment decision though taken by individual concerns is one of national importance
because it determines employment, economic activities and economic growth.

Importance of Investment Decisions / Capital Budgeting Decisions:

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 effects of investment decisions extend into the future and have to be endured for a
longer period than the consequences of the current operating expenditure. Unwanted or
unprofitable expansion of assets will result in heavy operating costs to the firm.
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 fluctuations in its earnings,
the firm will become more risky.
Funding: Investment decisions generally involve large amount of funds which make it necessary
for the firm to plan its investment programmes very carefully and make an advance arrangement
for procuring finances internally or externally.
Irreversibility: 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. Investment decisions once made cannot be reversed or may be reversed but at a
substantial loss.
Complexity: Another important characteristic feature of capital investment decision is that it is
the most difficult decision to make. Such decisions are an assessment of future events which are
difficult to predict. It is really a complex problem to correctly estimate the future cash flow of an
investment.
Investment Decision Process
The allocation of investible funds to different long term assets is known as capital budgeting
decisions. Capital budgeting is a complex process which may be divided into five broad phases.
1. Project generation
2. Project evaluation
3. Project selection
4. Project implementation
5. Controlling and review
1. Project generation: The planning phase of a firms capital budgeting process is concerned
with the circulation of its broad investment strategy and the generation and preliminary screening
project proposals.
The investments strategy of the firm delineates the broad areas or types of investments the firm
plans to undertake. This provides the framework which shapes and guides the identification of
individual project opportunities.
2. Project evaluation: If the preliminary screening suggests that the project is prima facie worth
while, a detailed analysis of the marketing technical, financial, economic and ecological aspects

is undertaken. The questions and issues raised in such a detailed analysis are described in the
following section.
The focus of this phase of capital budgeting is on gathering, preparing and summarizing relevant
information about various project proposals which are being considered for inclusion in the
capital budget. Based on the information developed in this analysis, the stream of costs and
benefits associated with the project can be defined.
3. Project selection: Selection follows an often overlaps, analysis. It addresses the questions. Is
the project worth while? A wide range of appraisal criteria have been suggested to judge to worth
while of a project. They are divided into two broad categories: Non discounting criteria and
Discounting criteria.
The principle in non discounting criteria is the pay back period and the accounting rate of return.
The key discounting criteria are the net present value, the internal rate of return and profitability
index.
To apply the various appraisal criteria suitable cut off values have to be specified. These are
essentially a function for the fix of financing and the level of project risk while the former can be
defined with relative case; the latter truly tests the liability of the project evaluation.
4. Project implementation:
The implementation phase for an industrial project which involves setting up of manufacturing
facilities consists of several stages.

Stage
Concerned with
Project and engineering design Site probing and prospecting, preparation of blue prints and plant designs,
plant engineering selection of specific machines and equipment.
Negotiation and contracting
Negotiating and drawing up of legal contracts with respect to project
financing, acquisition of technology, supply of machinery and know how and
marketing arrangements.
Construction
Site preparation, construction of buildings and civil work, erection and
installation of machinery and equipment.
Training
Training of engineers, technicians and workers.
Plant commissioning
Start up of the plant.
5. Project Review: Once the project is commissioned the review phase has to be set in motion.
Performance review should be done periodically to compare actual performance with projected
performance. A feedback device, it is useful in several ways,
1. It throws light on how realistic were the assumptions underlying the project.
2. It provides a documented long of experience that is highly valuable in future decision making.
3. It suggests corrective action to be taken in the light of the actual performance.

OR

An investment decision revolves around spending capital on assets that will yield the highest return for
the company over a desired time period. In other words, the decision is about what to buy so that the
company will gain the most value.
To do so, the company needs to find a balance between its short-term and long-term goals. In the very
short-term, a company needs money to pay its bills, but keeping all of its cash means that it isn't investing
in things that will help it grow in the future. On the other end of the spectrum is a purely long-term view. A
company that invests all of its money will maximize its long-term growth prospects, but if it doesn't hold
enough cash, it can't pay its bills and will go out of business soon. Companies thus need to find the right
mix between long-term and short-term investment.
The investment decision also concerns what specific investments to make. Since there is no guarantee of
a return for most investments, the finance department must determine an expected return. This return
is not guaranteed, but is the average return on an investment if it were to be made many times.
The investments must meet three main criteria:
1.

It must maximize the value of the firm, after considering the amount of risk the
company is comfortable with (risk aversion).
2.
It must be financed appropriately (we will talk more about this shortly).
3.

If there is no investment opportunity that fills (1) and (2), the cash must be returned
to shareholder in order to maximize shareholder value.

References:
Retrived from;
1. https://en.wikipedia.org/wiki/Investment_decisions
2. https://www.scribd.com/doc/61185804/Financial-Management
3. https://www.boundless.com/finance/textbooks/boundlessfinance-textbook/introduction-to-the-field-and-goals-offinancial-management-1/introducing-finance-22/types-offinancial-decisions-investment-and-financing-145-3871/