Investment Decisions

Expansion and Diversification

A company may add capacity to its existing product lines to expand existing operation. For example, the Company Y may increase its plant capacity to manufacture more “X”. It is an example of related diversification. A firm may expand its activities in a new business. Expansion of a new business requires investment in new products and a new kind of production activity within the firm. If a packing manufacturing company invest in a new plant and machinery to produce ball bearings, which the firm has not manufacture before, this represents expansion of new business or unrelated diversification. Sometimes a company acquires existing firms to expand its business. In either case, the firm makes investment in the expectation of additional revenue. Investment in existing or new products may also be called as revenue expansion investment.

Replacement and Modernization

The main objective of modernization and replacement is to improve operating efficiency and reduce costs. Cost savings will reflect in the increased profits, but the firms revenue may remain unchanged. Assets become outdated and obsolete with technological changes. The firm must decide to replace those assets with new assets that operate more economically. If a Garment company changes from semi automatic washing equipment to fully automatic washing equipment, it is an example of modernization and replacement. Replacement decisions help to introduce more efficient and economical assets and therefore, are also called cost reduction investments. However, replacement decisions that involve substantial modernization and technological improvements expand revenues as well as reduce costs.

Another useful way of classify investments is as follows

  • Mutually exclusive investment
  • Independent investment
  • Contingent investment

Mutually exclusive investment

Mutually exclusive investments serve the same purpose and compete with each other. If one investment is undertaken, others will have to be excluded. A company may, for example, either use a more labor intensive, semi automatic machine, or employ a more capital intensive, highly automatic machine for production. Choosing the semi-automatic machine precludes the acceptance of the highly automatic machine.

Independent investment

Independent investments serve different purposes and do not compete with each other. For example, a heavy engineering company may be considering expansion of its plant capacity to manufacture additional excavators and addition of new production facilities to manufacture a new product light commercial vehicles. Depending on their profitability and availability of funds, the company can undertake both investments.

Contingent investment

Contingent investments are dependent projects; the choice of one investment necessitates undertaking one or more other investment. For example, if a company decides to build a factory in a remote, backward area, it may have to invest in houses, roads, hospitals, and many more. For employees to attract the work force thus, building of factory also requires investment in facilities for employees. The total expenditure will be treated as one single investment.

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