(223)---REAL OPTIONS INVESTMENTS

Real Options Investments

Capital expenditure or investment planning and control involve a process of facilitating decisions covering expenditures on long term assets. Since a company’s survival and profitability hinges on capital expenditures, especially the major ones, the importance of the capital budgeting or investment process cannot be over-emphasized. A number of managers think that investment projects have strategic elements, and the investment analysis should be conducted within the overall framework of corporate strategy. Some managers feel that qualitative aspects of investment projects should be given due importance.

Capital investments

Strictly speaking, capital investments should include all those expenditures, which are expected to produce benefits to the firm over a long period of time, and encompass both tangible and intangible assets. Thus research and development expenditures are a capital investment. Similarly, the expenditure incurred in acquiring a patent or brand is also a capital investment. In practice, a number of companies follow the traditional definition, covering only expenditures on tangible fixed assets as capital investments. Large expenditures on research and development, advertisement, or employees trading, which tend to create valuable intangible assets, may cannot be included in the definition of capital investments since most of them are allowed to be expended for tax purposes in the year in which they are incurred. From the point of view of sound decision-making, these expenditures should be treated as capital investments and subjected to proper evaluation.

A number of companies follow the accounting convention to prepare asset wise classification of capital expenditures, which is hardly of much use in decision making. Some companies classify capital expenditures in a manner, which could provide useful information for decision making. Their classification is,

1. Replacement
2. Modernization
3. Expansion
4. New project
5. Research and development
6. Diversification
7. Cost reduction