Making capital investment decisions

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This topic is about the world of making capital investment decisions. A capital investment decision involves how the purchase of an asset can affect your business in a positive or negative manner. It also involves deciding what information is needed to be included in your decision, especially those that are financially related.

Investopedia defines capital investment as “Funds invested in a firm or enterprise for the purposes of furthering its business objectives. Capital investment may also refer to a firm’s acquisition of capital assets or fixed assets such as manufacturing plants and machinery that is expected to be productive over many years”.

The point of making a capital investment decision is to make a positive contribution to your cash flows today, and also in the future. Once you perform your calculations, you must decide if the asset acquisition is good or not so good for your business. To do this, the cash flows should be relevant to your business. By this I mean the change in your cash flows that does not produce a positive result should not be considered. You must consider the difference of cash flows generated with and without proceeding with your project. This basically means evaluating what the change in your incremental cash flows will be.

Without overly getting into the technical aspect of corporate finance, this means looking at the changes in your company’s cash flows as a direct consequence of taking on the project, on a stand-alone basis.  These incremental cash flows means examining what your opportunity costs will be and excluding any sunk costs out of your calculations.

You must also look into additions to net working capital as well. For example, will you need more inventory as part of the project? If so, then networking capital should be part of the project costs as well.

Don’t forget to include financing costs and the impact of inflation as well!

Any questions on capital investment decisions?

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