Quiz 19: Appendix Capital Investment Decisions: an Overview

Business

Capital investment decisions : Capital investment decisions are also known as capital budgeting decisions. It involves the judgements relating to investment in any project with an expectation of deriving benefits in the future. Capital investment decisions includes identification, analysis and selection of investment projects involving future cash inflows and outflows. Capital expenditure is done to expand the business operations of any enterprise. Some examples are: Purchase of plants, buildings, or acquisition of new machinery to expand the production capacity. Decisions relating to capital investment are generally made by the managers of finance department because it involves large amount of money and investment risk. Accountants and other finance experts assist managers in analyzing and evaluating various project proposals. They develop cash flow models to estimate the expected benefits of the project. Accountants play a vital role in the capital investment decision. The two most important factors they estimate in the investment decision are: 1. The amount of cash inflows and outflows used in capital investment decision models. 2. The timing of cash flows used in capital investment decision models.

The term time value of money refers to the concept that money in hand currently is actually worth more than money received in the future. •All capital investment decisions made by firms are based on the expected future cash flows of an investment opportunity. •These future cash flows are calculated based on the amount of the investment, the interest rate, and the length of time of the investment. •The timing of the future cash flows is very important. As cash is received from one investment, it can be immediately be reinvested , ensuring that money is not sitting idle but rather continuously earning more money.

It is important to understand the difference between revenues and cash inflows , as they are two different accounting concepts. •Cash inflows refer to the physical receipt of cash. However, cash inflows are not always received at the same time the related revenues are recognized. All cash flows are not revenues. For example cash received for loan taken is a cash receipt but not a revenue. •Revenues refer to the earning of money, but not necessarily the receipt of money. Remember, in accounting, revenues are recognized when they are earned (such as on the date of sale of a product) and not when they are received. •In capital investment analysis, cash flows are used rather than revenues and costs. This is because capital investment uses actual cash received for investment purposes.

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