What factors influence on Capittal Investment Decision.

Factors that Influence Investment Decision

Factors that Influence Investment Decision

Individuals , organizations and governments all in some form or the other make capital investments . Since these investments involve large amounts of money , investment decisions tend to be very critical and are therefore taken very carefully . The financial markets let both businesses and governments to raise the desired level of funds by different means . Investments can be made in bonds , securities , treasury bills , common and stocks . However , before going ahead with the investment it is important for the investors to determine the

br approximate returns and risks of the investments . One of the challenges faced by the investors is to earn the return they want while managing the risk involved . Some of the factors that influence capital investment decision are

Net Present Value (NPV

Payback Period

Accounting Rate of Return (ARR

Internal Rate of Return (IRR ) or Economic Rate of Return (ERR

Cost and Benefit Analysis

Government regulations

Competitors and improving existing working conditions

Economic conditions

Asset allocation

Risk involved

Ability to pay

When making investments it is important to make use of a cash flow analysis method that takes into account the time value of money that is the impact of inflation should be accounted for . Due to inflation the value of money in the future is worth less than the value of the same amount of money today . Many traditional financial analysis techniques fail to consider the time value of money which can lead to faulty decisions . The net present value (NPV ) is the most useful of these discounted cash flow methods . It compares the value of a dollar today to the value of that same dollar in the future , taking inflation and returns into account and it is expressed in after-tax dollars . It therefore helps make correct decisions . Investments with positive net present value add to shareholder wealth those with a negative net present value reduce shareholder wealth . Companies should therefore invest in positive NPVs and reject negative NPV (Shapiro 1990 : 186

On the other hand IRR can also be made use of . It helps investors to rank the various projects under consideration . The project with the highest IRR is considered and undertaken first . The IRR of one investment can be compared to rates of return of other securities in the market . However unlike NPV , IRR does not take into account the diminishing value of money . Pay back period helps the investors to determine which capital investment project would allow the company to recover their investment in the earliest possible time . Firms can set the number of years that they would want their initial investment to be paid back in e .g . if a company has set the payback time as 3 years then any machine taking more than three years to pay back its initial investment would be eliminated . Many investors prefer investing in projects where they could recover their investments in the earliest possible time if all other factors are same . A major shortcoming of the...