Question

Myra Ltd. manufacturing televisions is planning to expand its business and requires ₹250 crores for the same. A number of projects are available for the company to invest in and each project has to be evaluated carefully. The Finance Manager of the company has assessed the projects in terms of the rate of return from each project and wanted to select the one with the higher rate of return. But before selecting the project he has to take into consideration other factors also.

1. Identify and state the financial decision discussed in the above paragraph.
2. Explain the other factors that the Finance Manager should consider before selecting the project.

Answer 1

1. Investment Decision: A firm's resources are scarce in comparison to the uses to which they can be put. A firm, therefore, has to choose where to invest these resources, so that they are able to earn the highest possible return on their invesbnents. The investment decision, therefore, relates to how the firm's funds are invested in different assets. Investment decision can be long term or short-term. A long-term invesbnent decision is also called a Capital Budgeting decision. It involves committing the finance on a long-term basis. Short-term investment decisions (also called working capital decisions) are concerned with the decisions about the levels of cash, inventory and receivables. These decisions affect the day-to-day working of a business. These affect the liquidity as well as profitability of a business.
2. Factors affecting invesbnent decision are as follows:
   (a) Cash flows of the project: When a company takes an investment decision involving huge amount it expects to generate some cash flows over a period. These cash flows are in the form of a series of cash receipts and payments over the life of an investment. The amount of these cash flows should be carefully analysed before considering a capital budgeting decision.
   (b) The rate of return: The most important criterion is the rate of return of the project. These calculations are based on the expected returns from each proposal and the assessment of the risk involved. Suppose, there are two projects, A and B (with the same risk involved), with a rate of return of 10 per cent and 12 per cent, respectively, then under normal circumstance, project B should be selected.
   (c) The invesbnent criteria involved: The decision to invest in a particular project involves a number of calculations regarding the amount of investment, interest rate, cash flows and rate of return. There are different techniques to evaluate investment propo als which are known as capital budgeting techniques. These techniques are applied to each proposal before selecting a particular project.