The investment decisions of a firm generally known as capital budgeting or capital expenditure decisions. A capital budgeting decision may be defined as the firm’s 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 year. The long term assets are those which affect the firm’s operations beyond the one year period. The firm’s investment decision would generally include expansion, acquisition, modernisation and replacement of long term assets. Sale of a division or business (Investment) is also analysed as an investment decision. Activities such as changes in the methods of sales distribution or undertaking an advertisement compaign or a research and development programme have long-term implication’s for the firm’s expenditure and benefits and therefore, they may also be evaluated as investment decisions.
1) The exchange of current funds for future lengths.
2) The funds are invested in long term assets.
3) The future benefits will occur to the firm over a series of year.
Importance of Investment Decisions
Investment decision require special attention because of the following reasons:
1) They influence the firm’s growth in the long turn.
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.
A firm’s decision to invest in long term assets has a decisive influence on rate and direction of its growth.
A wrong decision can prove disastrous for continued survival of firm, unwanted or unprofitable expansion of assets will result in heavy operating costs to the firm. On other hand, inadequate investment in assets would make it difficult for the firm to complete successfully and maintain its market share.
A long-term commitment of funds may also change risk complexity of the firm. If the adoption of an investment increases overage gain but causes frequent fluctuations in its earnings the firm will become more risky.
Investment decisions generally involve large amount of funds which make it imperative for firm to plan its investment programmes very carefully and make an advance arrangement for procuring finance internally or externally.
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 are an assessment of future events which are difficult to predict. It is really a complex problem to correctly estimate future cash flow of an investment. The uncertainty in cash flow is caused by economic, political, social and technological forces.