When making a capital investment decision the goal is to maximize the wealth of the stakeholders. In order to do so, stakeholders will analyze the current financial state of the company. The analysis of the company’s financial status will inform the stakeholders of the number of funds available to make an effective capital investment decision. When decisions are being made, they are aiming to include an effective manner to ensure the best possible returns overall, the amount of funds available helps to aid in making the right capital investment decision otherwise risking a negative return. Projects that may produce a positive return will earn the company a substantial amount of wealth and will be their first priority. The amount of available funds helps to determine the best time in choosing and investing in capital.
Companies apply different methods to make capital investment decisions. Some of those methods that are used to make decisions are present value and internal rate of return. According to “Present Value” (2017), “Present value (PV) is the current worth of a future sum of money or stream of cash flows given a specified rate of return” (para. 1). Whereas according to “Rate of Return” (2017), “A rate of return is the gain or loss on an investment over a specified time period, expressed as a percentage of the investment’s cost” (para. 1).
When determining the right capital investment decision all must contemplate the goals of the company and what positive return will the decision have on the success of the company. Using the present value method if the total is greater than zero, the project is worth doing. The higher the net present value the better. Alternatively, if the IRR is greater than your discount rate the project may be worth investing being that the IRR is higher (“Time Value of Money”, 2017). These tools will help companies know whether it’s worth the investment.
How the Cost of Capital Is a Factor in the Decision-Making Process
The cost of capital is critical and is essentially the return within the decision-making process because it can assist in the decisions of the finances. The cost of capital is vital to investor decisions, in which allows them to decide on investments that will provide them a greater return. The cost of capital is a factor in making decisions in the areas of capital budgeting, designing the structure, evaluations, financing a project, risks and income, and dividends. First, the reason the cost of capital has a role within the capital budgeting process is to determine if there is acceptance or not. Secondly, the designing of structure capital relies on the cost of capital for both reasons which are balanced and optimal. Third, when determining how to finance a project the cost of capital plays a vital role when dealing with the sources that are available. Fourth, the evaluation is another point that the cost of capital connects because within the performance evaluation the cost of capital can help with the comparison of the money. Fifth, the cost of capital can help within know about both the risks and income. If there is a large growth of the cost of capital and the money is low, then it would be easier to figure out that there is a risk involved and the cost of capital is a factor to the portion of both financing and dividends too. Overall, the cost of capital has a significant role in the decision-making process and it is critical within the organizations (“MBA Knowledge Base”, n.d.).
Capital investment decisions refer to a firm’s acquisition of capital assets or fixed assets, which are the funds available for the firm to invest in to further their business objectives. The decisions a company makes regarding their capital investments are crucial to the success of the company, which can increase their value. The primary objectives in investing are obtaining a positive net value, setting priorities, purchasing assets for positive returns, and keeping debt in line. It is also crucial that a company determines if the investment will yield a sufficient return and if so, the company must determine how to finance the investment (University of Phoenix, 2017). When making capital investment decisions the goal is to maximize the wealth of the stakeholders. To do so, the company must have sufficient funds available to make effective capital investments. When decisions are being made, a company must choose the investment that will bring a positive return to be successful. However, choosing the wrong investment could risk a negative return, in which would not maximize the wealth of the stakeholders and the company would not be successful. Furthermore, the cost of capital plays a vital role in investor decisions, which allows them to determine which investment will most likely provide them with a greater return. The cost of capital is a factor in the decision-making process in the areas of capital budgeting, financing projects, and evaluating the income and risks. Finally, the number of funds available, the objectives of capital investments, and the cost of capital all play a crucial role in capital investment decisions.