Capital Investment Decisions

Capital investment is defined as the acquisition of a fixed asset that is anticipated to have a long life of use before it has to be replaced or repaired. Capital investment is the money invested in a business venture with an expectation of income, and recovered through earnings generated by the business over several years. It is the capital expenditure than for day-to-day operations or the working capital or other expenses.

The capital investments decisions are defined as long-term corporate finance decisions relating to fixed assets and capital structure. In finance, the capital investment decisions are also referred as capital budgeting. These decisions are based on many criteria. First of all the corporate management seeks to maximize the value of the firm. This is done by investing in projects that yield positive net present value using an appropriate discount rate. Secondly the projects must be financed properly. Lastly if such opportunities do not arise then the company should maximize shareholder value dictates that management must return excess cash to shareholders. Thus capital investment decisions comprises of an investment decision, a financing decision, and a dividend decision.

The capital investment decisions are based on the net present value, project valuation in a risk less world (Fisher’s Principle), present value and compounding and present value with special cash flows. The capital investment decisions of a firm are mainly governed by the process of ranking and identifying the capital investments of the firm. Hence to get most value out of the business the firm needs to decide which of the given investments.

The capital investment decisions also face a few constraints. Firstly the amount of capital that a firm would collect is limited and it brings down the constraint on the choice of the firm over various project investments. The debt-equity ratio of the firm increases with the increase of the debt of a firm and hence it becomes difficult for the business to raise more debts.

Questions

• What are capital investment decisions?
• What are its criteria?