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Factors that influence Capital Investment Decisions

16 Feb 2017Economics Essays

INTRODUCTION:

Capital investment decisions are critical. It involves large sums of money. The company must use the different capital investment decision tools in order to forecast whether the company will benefit from investing in buying high value factory equipments. Some of the tools like payback period, cost –benefit analysis, competitors, government regulations are only some of the factors that influence capital investment decisions (Dayananda et al. 2002, 6). The following paragraphs explain in detail the different factors that influence capital investment decisions.
BODY:

There are many factors that influence capital investment decisions. First, the net present value is a valuable tool for determining whether to purchase new manufacturing equipment that entails large cash outlays. And, the payback period is influential on capital investment decisions. In addition, another factor that influences capital investment decisions is government regulation. Further, valid and relevant information is another factor that influences capital investment decisions. Also, the competitor is a good factor in capital investment decisions. And, the ability to pay is a good factor in capital investment decisions. Plus, improving the working conditions of the factory would be a very good factor in capital investment decision. Further, replacement of worthless factory equipment is a good factor for capital investment decision. Finally, Analysis of the cost and the benefit derived from the capital investment is a must (Mcmenamin 1999, 169).

First, the net present value is a valuable tool for determining whether to purchase new manufacturing equipment that entails large cash outlays. The company uses this tool in order to determine whether the present value of the total cash inflows is more than the cost of the huge capital investment. Next, the discounted cash flow approach known as accounting rate of return is another tool to determine if a large capital investment would be a good decision. Evidently, the net present value is a valuable tool for determining whether to purchase new manufacturing equipment that entails large cash outlays is positive (Dayananda et al. 2002, 23).

And, the payback period is influential on capital investment decisions. This tool helps the investors to determine which capital investment project would allow the company to recover their investment in the earliest possible time. Many investors prefer investing in projects where they could recover their investments in the earliest possible time if all other factors are evenly. For example, Alternative A capital investment decision would generate cash inflows of $200,000 a year would result to ten year payback period of factory equipment that costs only $2,000,000. Alternative B capital investment decision would generate cash inflows of $ 400,000 would result to the five year payback period of factory equipment that also costs $2,000,000. Here, applying Alternative B is the better capital investment decision to make. Surely, the payback period is influential on capital investment decisions (Flynn 2001, 14).

In addition, another factor that influences capital investment decisions is government regulation. For example, the company must comply with new government regulations require that the current factory equipment must comply with the government's anti –pollution or other environmental laws. For, the government inspecting agencies discover that the current factory equipment produces too much polluting smoke emanating from the company's smoke exhaust outlets (Freedman, and Jaggi 1993, 6). In addition, the company must invest in equipment that would help keep the company's wastes from polluting the nearby pristine lakes in order to avoid being penalized by the government for violating the environmental laws. Clearly, another factor that influences capital investment decisions is government regulation (Hunter, and Waterman 1996, 34).

Further, valid and relevant information is another factor that influences capital investment decisions. Valid and relevant information means that the data received pertains to the capital investment decision. For example, the color of the machine to be bought would normally not be relevant to decision making. But, information that states that alternative machine A can produce a maximum of 100,000 finished products per year as compared to Alternative B's maximum capacity production of only 90,000 units would be very relevant for the manager to decide whether to buy alternative A machine or alternative B machines. Unquestionably, valid and relevant information is another factor that influences capital investment decisions (Cook, Grove, and Coburn 2000, 305).

Also, the competitor is a good factor in capital investment decisions. The company must replace its obsolete factory equipment with new ones that would increase the production of its finished products. Also, new equipment would also increase the quality of the finished products. This type of capital investment decision making would normally be triggered by the competitors' ability to produce more products. Also, the competitors' purchase of new factory equipment that has improved the quality of their products offered in the markets would surely cause the company to also replace their old machines with more modern factory equipments. Truly, the competitor is a good factor in capital investment decisions (Elkin 1998, 48).

And, the ability to pay is a good factor in capital investment decisions. For, many suppliers of the large value capital equipment would need to be paid before they will send their equipment to the company. A company that does not have the have the cash would not be able to buy the equipment. However, some suppliers of high value factory equipment would need assurances that they will be paid in installments when they time for collecting the regular monthly, quarterly or annual installments fall due before releasing the factory equipment to their factory clients. Glaringly, ability to pay is a good factor in capital investment decisions (Holewinski 1993).
Plus, improving the working conditions of the factory would be a very good factor in capital investment decision. The company would surely pride itself in replacing the old equipment that is too noisy or creates a very hot working environment with a new factory equipment that creates finished products in silent mode and the machines are do not create a hot working environment. Consequently, the new equipment would increase the employees' morale. The increase in morale would result to increase in the employees' production outputs as well as the quality of their finished products. Yes, improving the working conditions of the factory would be a very good factor in capital investment decision (Martin 2000, 67).

Further, replacement of worthless factory equipment is a good factor for capital investment decision. The company needs factory equipment to produce its finished products. A worthless factory equipment is one that can no longer produce the same quality of goods because it has already worn out or its machine parts are eroded beyond repair. Choosing the Alternative of buying new equipment would be a better capital investment decision than to choose the alternative of continuous replacement of the machine parts as well as and the repetitious repair of the machine that would be more costly than to buy a new equipment. Undoubtedly, replacement of worthless factory equipment is a good factor for capital investment decision (Neeley 1992).

Finally, analysis of the cost and the benefit derived from the capital investment is a very good factor in capital investment decisions. Here, the investors would want to know if the total revenues or benefits form the purchase of a new equipment would be more than, equal to or less than the cost of buying such high value Asset. For example, the investors would surely not invest in new equipment that costs $1,000,000 if the total revenues generated during the entire useful life of the equipment would be less the $1,000,000 equipment cost. Truly, analysis of the cost and the benefit derived from the capital investment is a very good factor in capital investment decisions (Anderson et al. 2000, 89).

CONCLUSION:

The topic above is very important and significant in terms of capital investment decisions. Evidently, the Net Present Value is a valuable tool for determining whether to purchase new manufacturing equipment that entails large cash outlays is positive. Surely, the payback period is influential on capital investment decisions. Clearly, another factor that influences capital investment decisions is government regulation. Unquestionably, valid and relevant information is another factor that influences capital investment decisions. Truly, the competitor is a good factor in capital investment decisions.
Glaringly, ability to pay is a good factor in capital investment decisions. Yes, improving the working conditions of the factory would be a very good factor in capital investment decision. Undoubtedly, replacement of worthless factory equipment is a good factor for capital investment decision. Truly, analysis of the cost and the benefit derived from the capital investment is a very good factor in capital investment decisions. Conclusively, the current status of the subject as discussed above has not changed a bit since their conception several years ago. Correctly, there are no negative effects of the above factors in influencing capital investment decisions.

Works Cited

  • Anderson, Fred, Mary Ann Chirba-Martin, E. Donald Elliott, Cynthia Farina, Ernest Gellhorn, John D. Graham, C. Boyden Gray, Jeffrey Holmstead, Ronald M. Levin, Lars Noah, Katherine Rhyne, and Jonathan Baert Wiener. 2000. Regulatory Improvement Legislation: Risk Assessment, Cost-Benefit Analysis, and Judicial Review. Duke Environmental Law & Policy Forum 11, no. 1: 89.
  • Cook, Thomas J., Hugh D. Grove, and Steve Coburn. 2000. ABC Process-Based Capital Budgeting. Journal of Managerial Issues 12, no. 3: 305.
  • Dayananda, Don, Richard Irons, Steve Harrison, John Herbohn, and Patrick Rowland. 2002. Capital Budgeting: Financial Appraisal of Investment Projects. Cambridge, England: Cambridge University Press.
  • Elkin, Paul. 1998. Mastering Business Planning and Strategy: The Power of Strategic Thinking. London: Thorogood.
  • Flynn, Tom. 2001. Branch Buying: How Do I Tell a Plum from a Lemon?. ABA Banking Journal 93, no. 8: 14.

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