Capital Investment- Its Significance and Techniques used

Capital investment decision

In any business, an investment is made to procure some resource or technique that will aid in better production and ultimately help to increase revenue. It is a kind of expenditure to the company. Usually, expenditure is of two types, one is the general operating transactions expenses which is called current expenditure and the expenditure of buying assets for the better production process which is the capital expenditure.

Current expenditure benefits can be achieved in a short period of one year and the capital expenditure helps to get results in the future. Making the decision between this two expenditure is a task which the finance department will deal with.

What are capital investment proposals?

Before fetching profits there is a long way to decide what could be done for the profit achievement. The required investment proposals can be as follows:

  • Purchase of land or equipment or new building for acquiring a new business.
  • Replacement and maintenance of an existing capital asset.
  • Expenses for better research and development required.
  • Leasing or buying any project

The significance of capital investment decisions

These decisions are the ones, which justify how well an investment aimed at future will benefit the company and in what ways. Some of the significances of these decisions are:

  • Investment-linked decisions: if the objective of an industry is to survive and grow then it decides to invest in buying fixed assets which are an investment for better production.
  • Long-term projects: some projects are the ones which are decided now and they reap the benefits in future, such long-term projects are also an objective of most businesses.
  • Never think back: it is not at all an easy task to reverse a capital decision.

There are some valuation techniques which are used to calculate the capital investment measures. These work with certain unique formulas and have accurate ratios and numerical analysis. Some of the common methods are

  • Payback period: this is a technique which calculates the number of years to get back returns on an investment.
  • Present worth method: this is the most significant method and accurate one that calculates the present value of the new equipment. Thus to compare future prices are calculated at today’s rate.
  • The rate of return method: this method calculates the average annual net income is expressed as a percentage of capital investment.

These are commonly used to find the values of the capital investment decisions and their effects.



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