Business Capital Investment

This research examines the process of business capital investment under conditions of uncertainty. Capital investment decision-making methods that accommodate conditions of uncertainty are reviewed.

Effective and efficient decision-making is important in the capital investment process because financial resources are typically scarce. Conditions of uncertainty, competing goals, and utility tend to complicate the decision-making process. The selection from among alternatives in the capital investment process is generally referred to as capital budgeting. Capital budgeting involves the making of investment decisions related to fixed assets and other long-lived assets.

The "capital" in capital budgeting refers to the investment of financial resources in assets, while the "budgeting" refers to the revenue inflows and outflows related to the capital investment over a specified period of time. Budgeting in this perspective also refers to the process of rationing or allocating available capital resources, when available capital resources are not sufficient to fund all desirable projects.

The purpose of capital budgeting is two-fold. First, the process must determine whether or not a proposed capital investment will be a profitable one over the specified time period. Second, the process must provide management with a means of selecting between alternatives. It is essential for management to have an effective and an efficient means of

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is an effective means of allocating capital among competing uses. Cost of capital determinations also play a role in leverage decisions. There are a number of capital budgeting decision methods. Seven of the most widely used and accepted of these methods are (1) the payback period method, (2) the present value method, (3) the internal rate of return method, (4) the project profitability index method, (5) the capital asset pricing model method, (6) the efficient frontier method, and (7) the time state preference method. The payback period refers to the time required for the initial outlay on any proposed project to be recovered. This method may be used in two different ways. First, a project may be required to payback the initial outlay within a specified period of time, before it is considered to be acceptable. Second, the payback periods for two or more competing proposals may be compared, for purposes of selecting one or more for implementation. Projects providing for the shortest payback periods would be selected. The payback period method is a relatively unsophisticated method. The time value of money concept leads to the use of what is called the net present value concept, which is used capital budgeting.

Category: Economics - B