The capital investment decisions can also be termed as capital budgeting in finance. The purpose of the capital investment decisions includes allocation of the firm’ s capital funds most effectively in order to ensure the best return possible.
Evaluating the projects and allocating capital depending on the requirements of the projects are the most important aspects of capital investment decisions.
There may be various criteria for selecting the right and appropriate decision for capital investment. For example, a firm may emphasize on the projects that promise for the immediate return while some other firms may insist on the projects that ensure long term growth. The major goal of capital investment decision is to increase the value of firm by undertaking right project at right time.
The capital investment decisions are mainly governed by the process of ranking and identifying the capital investments of the firm. The firm needs to decide which of the given investments will ensure the most value to the business.
The decisions of capital investment often suffer from a number of constraints. The amount of capital that a firm collects is limited and it brings down the constraint on the choice of the firm over various project investments. As the debt of the firm is increased, the debt-equity ratio of the firm also gets increased and hence it becomes difficult for the business to raise more debts.
The decision of project ranking plays significant role in the decisions of capital investment. Depending on the various projects the firm is having at a certain period of time, the firms prioritize the projects. The ranking of projects depends on how much a project will return and which project will be able to add maximum value to the business.
There are various measures that give the estimation of the return of the firm over various investment projects. In order to determine the value of a particular project, three most famous methods are – IRR methods, net present value and payback method. These methods are applied while taking decisions on capital investment.
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