Usually, in investment problems, much attention is focused on how to choose among alternative projects, so that one is tempted to believe that this constitutes the only problem in capital decisions. However, if we examine carefully, it is easy to realize that choice among alternatives is only one facet albeit the important facet of the problem from the top management perspective. The other facets are implementation and control as applied to all phases of capital investment, and these are important aspects because, in the ultimate analysis, the top management is accountable to the Board of directors and owners for the success or failure of investment plans.
Let us examine in brief how investment decisions are influenced by the management perspective. Obviously, we have to start with the company objectives which provide broad guidelines to policies, plans, and operations. A possible objective might be to maximize return on investment in which case the management might seek to minimize investment by selecting only a few capital projects that yield the highest returns. On the other hand, the objective may be to maximize sales volume and in that case, all capital investment that yields a net profit (maybe small) would be made without undue concern. If the management is guided by a growth objective, expansionary investment involving high capital cost would be undertaken.
INVESTMENT DECISIONS – MANAGEMENT PERSPECTIVE
Within the board company objectives, top management also reviews the competitive position of the company and if the competition is sharper, the management looks out continuously to evaluate and upgrade the equipment to achieve greater efficiency at the least cost. In big companies, the management sets out policies to guide lower levels of management in the search for evaluation of and initiation of capital projects.
The top management has also to keep watch on company funds that finance investments. It cannot allow funds to lie idle just because the suitable project is not at hand. The cost of idle funds is substantial and hence the need for looking out for suitable investment opportunities. If such opportunities exist then the management must spare funds and if existing funds are inadequate it should raise funds externally. It should be remembered that if there is no profitable investment opportunity within the company, the dividend policy of the company should be liberal. Funds for capital investment must be arranged on a long-term basis otherwise borrowings short and investing long can lead to a lack of liquidity and consequent troubles. The major sources of long-term funds are long-term borrowing, new equity capital (sale of stock), and retained earnings. Sometimes, a change in the inventory system also releases funds by effecting a reduction in inventory to be carried. The selection of the right source of funds is again influenced by management’s own belief and value judgment and other factors like outsider control, dilution of equity, price-earnings ratio, cost of funds, etc.
And finally, the top management is usually concerned with the implementation and control aspects of investment projects. Specific responsibilities are to be assigned to specific individuals or cells and progress reports have to be carefully studied. In big projects, improved methods like program evaluation review technique (PERT) or critical path method (CPM) may be used.