One of the significant decisions a firm has to take is â€œwhat to produceâ€? This question is relevant not only for a few enterprises but also for an existing firm. This is so because while a new entrant must decide the good it would like to produce, an existing unit might like to expand its activities either in the old line or in a new line. Today, the competition is tough, most firms are going in for diversification, and more and more of new products are coming out month after month. In the circumstances, a firm has to constantly examine the viability of its old ventures vis-Ã -vis new ventures. Since the number of goods a firm could produce is much more than what a firm could possibly undertake and production involves investments, investment analysis is an inevitable activity of every firm.
Investment is an economic activity of employment of funds with the expectation of receiving a stream of benefits in future. Thus, it would include commitments of funds in
1. Financial assets
2. Physical assets
3. Productive activities
The first group includes bank deposits, contributions to provident fund, purchases of national savings certificates, and units of Unit Trust of India, company deposits, shares and debentures of companies, etc. The second category consists of purchases of precious metals (gold, silver and diamond), land, building and even other durable goods, which are purchased not for use but for profit making. Thus, if an individual buys a house not for living in it but for renting it out or even for selling it at a later date, it is an investment activity. The last category, viz. investment in productive activities, consists of investments in the production of goods and services. Thus, if anybody wants to quit his job and start a firm to manufacture computers or television or to supply management consultancy services or to run educational institute, he would need funds, commitment of which in any one of these and similar activities would mean investment in a productive activity.
In terms of the formal definition all the three types of the above activities refer to investment. However, in the practical sense, investments in productive activities alone are considered as capital expenditures (the phrase synonymous to investments), and these alone analyzed under the subject â€œcapital budgetingâ€. Investments in financial and physical assets are considered as â€œportfolio management.â€
Capital expenditures on replacements include those on replacements of worn out machines by identical new machines, replacements of obsolete plants/machines by modern plants/machines, replacements of labor by machines, relocation of factory/office, renovation of factory/office etc. These expenditures are obviously undertaken by the existing firms only.
Capital expenditures on expansion consist of those incurred on the enlarging capacity in the existing lines and new lines of production. For example, if an existing cotton textile firms, having a capacity of, say 10,000 meters of cloth per month wishes to expand, it could do so in a number of ways. First, it could increase its capacity in the cotton textiles business from 10,000 meters per month, to say, 20,000 meters per month. Second, it could launch on a new but allied production say of woolen and synthetic clothing. Third it could simultaneously start manufacturing some unrelated good, such as computers, computer printers, televisions, calculators or even in hospitality industry. The first category belongs to expansion in the old product line group, the second to diversification in allied line and the last to diversification in non-allied line group. While the existing firms could go for anyone of these three expansions, the new entrants (investors) could think of diversifications in the non-allied line only.
Capital expenditure of strategic nature includes those on improving the welfare of the employees and on reducing the risk of the business. The former category consists of expenditures incurred by a firm on providing facilities such as canteen, indoor games, common room with musical instruments, etc and on controls of air pollution, etc. There are strategic investments, for these might resolve industrial relations problem which hamper production and factory efficiency. A product manager has to carefully assess the mood and motives of the union leaders to decide such expenditures. If it works a little investment of this kind can save a firm from serious disputes and strikes, but if it does not work, it would mean unnecessary capital expenditure.