Investment decisions require special attention because of the following reasons:
- They influence the firm’s growth in the long run
- They affect the risk of the firm
- They involve commitment of large amount of funds
- They are irreversible, or reversible at substantial loss
- They are among the most difficult decisions to make
Growth
The effects of investment decisions extend into the future and have to be endured for a longer period than the consequences of the current operating expenditure. A firm’s decision to invest in long term assets has decisive influence on the rate and direction of its growth. A wrong decision can prove disastrous for the continued survival of the firm; unwanted or unprofitable expansion of assets will result in heavy operating costs to the firm. On the other hand inadequate investment in assets would make it difficult for the firm to compete successfully and maintain its market share.
Risk
A long-term commitment of funds may also change the risk complexity of the firm. If the adoption of an investment increases average gain but causes frequent fluctuations in its earnings, the firm will become more risky. Thus, investment decisions shape the basic character of a firm.
Funding
Investment decisions generally involve large amount of funds, which make it imperative for the firm to plan its investment programmers very carefully and make an advance arrangement for procuring finances internally or externally.
Irreversibility
Most Investment decisions are irreversible. It is difficult to find a market for such capital items once they have been acquired. The firm will incur heavy losses if such assets are scrapped.
Complexity
Investment decisions are among the firm’s most difficult decisions. They are an assessment of future events, which are difficult to predict. It is really a complex problem to correctly estimate the future cash flows of an investment. Economic, political, social and technological forces cause the uncertainty in cash flow estimation.
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