Capital Investment decisions require special attention because of the following reasons:
- They have long-term implications for the firm, and can influence its risk complexion.
- They involve commitment of large amount of funds.
- They are irreversible decisions.
- They are among the most difficult decisions to make.
- Safety: Investing in instruments such as government-issued securities in stable economic systems or through the purchase of the highest quality corporate bonds issued by the economy’s top companies provides relatively more stability and safety than other investments. Such securities provide the best means of capital preservation receiving a specified rate of return. Other similar investments are:
- Income: Income generation is one of the top results expected from an investment in order to keep up with the inflation or retirement. The highest return with the lowest risk is strived for. The safest investments have the lowest rate of income return, or yield. Investors must inevitably sacrifice a degree of safety if they want to increase the yields. This is the inverse relationship between safety and yield: as yield increases, safety generally goes down, and vice versa.
- Growth of Capital: Capital gains are different from yield. They are only realized when the security is sold for a price that is higher than the price at which it was originally purchased. Selling at a lower price is referred to as a capital loss and therefore, investors seeking capital gains are likely not those who need a fixed, ongoing source of investment returns from their portfolio, but rather those who seek the possibility of longer-term growth.
- Tax Minimization: Investments are also made with the intention of availing tax benefits. A highly-paid executive, for example, may want to seek investments with favourable tax treatment in order to lessen his or her overall income tax burden.
- Marketability/Liquidity: Many investments are reasonably illiquid. That is they cannot be immediately sold and easily converted into cash. Achieving a degree of liquidity requires the sacrifice of a certain level of income or potential for capital gains. Common stock is often considered the most liquid of investments, because it can be sold on immediate basis. Bonds can be fairly marketable though many are highly illiquid, or non-tradable, possessing a fixed term. Similarly, money market instruments may only be redeemable at the precise date at which the fixed term ends. If an investor lays emphasis on liquidity, money market assets and non-tradable bonds may not be chosen for his/her portfolio.
