3 Major Types Of Investment Decision Making

In the word used in finance management, before investment decision, the term “investment” refers to a decision and capital budgeting should be considered. Capital budgeting and investment decision are not different actions in the business world. In the context of investment capital, the term “capital” is understood as referring to tangible assets that can take on any form, buildings, plants, machines, raw materials, and so on. In contrast, the term “investment” refers to any tangible assets.

Also, the investment decision is about what capital assets that are added today can boost the revenue in the future to pay for costs. So, investment decisions are an investment of funds at various times to anticipate economic returns in the future.

The decision must be made from the available alternatives to sources of income for investments since investments are based on the possibility of purchasing tangible assets throughout a production process.

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Factors Affecting Investment Decision Making

In the words of Prof. Ezra Solomon, for making optimal investment decision, the following types of data are needed:

(i) Estimation of capital outlays as well as the future earnings of the project that focuses on the job that involves value engineering as well as forecasting the market.

(ii) Capital availability and the consideration of cost-focusing focus as an analysis of financials.

(iii) A proper set of standards to use to choose projects for execution to maximize return, focusing on logic and math.

1. Estimate Of Future Earnings And Capital Outlays Of The Proposed Project

3 Major Types Of Investment Decision Making
3 Major Types Of Investment Decision Making

A company’s management is guided by numerous factors when predicting future revenue streams that result from current investment decisions. If the current management practice, the period for the accrual of benefits is more than one year, then the investment is called investment, and the cash used is known as capital expenditures. Fixed capital expenditures show the price or outlay made by the firm to build the production capacity.

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The critical times for these costs are the following:

(i) Advance Expenditure:

The costs for economic and technical feasibility reports as well as plant design, license fee, and costs associated with its expenses related to the search for finance as well as other related items are included in this category.

(ii) Land And Site Development Expenditure:

This is the price of land purchased or leased, costs for creating the property usable, the laying of roadways, fencing, and so on.

(iii) Construction Costs:

The cost of factories, houses for residential use roads, roads and electrical pipelines, drainage system water supply, etc.

(iv) Machines And Tools:

The price of the machinery must comprise the purchase price of the machine as well as tax, duty and freight insurance, transport costs, etc. Different kinds of tools are required for the operations, and the cost of these sets in the plant will depend on the price of the devices.

(v) Erection Of Equipment:

The entire plant comprising diverse types of equipment is required to be assembled at the plant’s location. Payments for installation will be counted within this category.

(vi) Training Expenses:

An organization considering purchasing these machines must have its staff trained to use these machines. The cost of the training must be taken into account.

(vii) Franchise Cost:

The expense of obtaining approval from government agencies or other institutions can also be covered in this group.

(viii) Cost Of Mobilizing Finance:
The companies raise money through bonds, shares, debentures, and fixed deposits from the public. A carefully selected portfolio among the various securities on the market can assist the investor in achieving his goals.

(ix) Price Of Inventory:

The decision to store inventory to satisfy demand is vital for a business, and, in certain circumstances, the amount of stock is used as a reference point for planning production. The benefit of these safety inventories will be part of the cost of establishment.

The above expenses are associated with the setting up of an industrial plant. When the plant is set to operation, it will require several funds to cover the operational costs.

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The main types of these costs are as they are:

(i) Labour cost,
(ii) Repairing costs and maintenance costs,
(iii) rent and royalties,
(iv) Charges for insurance,
(v) Cost of stationery,
(vi) Tax payment and duties, as well as
(vii) Power and fuel costs.

In addition to the types mentioned above, other categories of annual costs include depreciation and interest costs. Investment decisions directly impact financial decisions. The acceptance of an investment proposal will depend on its funding.

2. Capital Sources

3 Major Types Of Investment Decision Making
3 Major Types Of Investment Decision Making

Capital sources are classified into four categories:

(i) Internal Capital:

The company itself generates this. It comprises retained profits and depreciation provisions taxation provisions, along with other funds.

(ii) Short-term Capital:

It is required to cover the day-to-day costs (working capital).

(iii) Medium-term Capital:

It could purchase equipment and plants or permanent or semi-permanent additions to the current assets. It could be of any application ranging from one and ten years.

(iv) Long-term Capital:

It is required to fulfill the demands of fixed capital creation.

3. Cost Of Capital

3 Major Types Of Investment Decision Making
3 Major Types Of Investment Decision Making

Capital cost plays an essential role when evaluating investment decisions. If a company needs to borrow capital from various sources, it needs to scrutinize the costs before making the final decision. It is an amount that a lender borrows to use funds belonging to another person. Thus, it’s an exchange between the deficit and surplus units.

The investor must be aware that he must deal with different interest rates referred to by various names. To succeed as an investor, one must recognize the different interest rates and set them. Investors should also study the various interest rates available in the market before investing.

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Different types of interest rates that are available in the cost capital market are shown below:

(i) Ceiling Rate of Interest:

It is the highest rate of interest that is usually set by both the Government of India and the RBI. It is determined by the face value of the financial instrument.

(ii) Coupon Rate of Interest:

It’s the rate of interest calculated on the value of the bond or debenture. Anyone who buys a debenture or bond with a long-term maturity is expecting an interest payment in the form of a coupon.

(iii) Market Rate of Interest:

It is the value of future cash flows created by investing and the cost of financing.

(iv) Long-term Interest:

It covers a period that is usually longer than five or ten years.

(v) Medium-term Interest:

It can differ from one year up to five years.

(vi) Short-term Interest:

It is different for each day, week, and month, and the most years for it to be considered is one year.

Conclusion

This article has most of what you need to know on the investment decision-making process as an investor in Nigeria or outside Nigeria, whichever is read till the end of this article.

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