Characteristics of Capital Investment

A capital investment involves a current cash outlay in anticipation of realizing benefits in the future, generally (well) beyond one year. These benefits may be either in the form of increased revenues or reductions in costs -the expenditures are called accordingly as income-expansion, or cost-reduction, expenditures. The cash outlay (as capital expenditure) may go towards addition, disposition, modification, creation and replacement affixed assets. The basic features of capital investment decisions are thus : 

1. a series of large anticipated benefits; 
2. a relatively high degree of risk; and 
3. a relatively long period over which the returns are likely to be realised. 

It must be mentioned that the following descriptions are used synonymous : capital investment decision, capital expenditure decision, capital expenditure management, long-term investment decision, management of fixed assets, capital budgeting decision. 

The simplest assumption underlying capital investment decisions is that the required rate of return is given and is the same for all investment projects. This rate of return is designated as the minimum acceptable rate of return (MARR). This assumption presupposes that the selection of any investment project does not alter the L'business-risk companion" of the firm as visualised by the suppliers of capital. Thus, risk, and rate of return are important considerations in capital investment decisions; generally, unless otherwise indicated, risk is held to be constant. Of course, the rate of return may vary with the risk. 

Strategic decisions in regard to capital investment may lead to significant changes in the firm's expected profits and in the risks to which these profits will be subjected to. These changes may influence stockholders and creditors to revise their evaluation of the firm. 

An investment decision at the right opportunity can boost the profits for quite a few years to come; equally, an ill-advised investment [nay even lead to bankruptcy. Besides this, other impacts on the firm due to any long-term investment may include the following : 

1. Any fixed investment is attended by certain fixed costs in terms of labour, rents, insurance, staff salary, etc. and hence, the break-even points, sales and profits for product ranges would be changed. 
2. Capital investments, once made, are irrecoverable except with losses. There may not be even scrap value in certain cases. 
3. Since funds are blocked on the acquired fixed assets, other investment opportunities may not be financed for want of funds; and thus, besides losses on this asset, potential profits from alternate investments are also lost. 

Since future is generally uncertain, there is always an element of risk in estimating the future benefits from an investment. Reliable forecasts of market demands, market share for the firm, consumer preferences, competitors' actions and offers, technological development, changes in economic and potential environment - are the agglomerate of requirements to be carefully looked into. Quantifying the benefits is thus often a "grey" area.