Importance of Selecting The Right Projects

When discussing investments, we’re also discussing money being spent, in order to determine the best possible outcome, it is extremely important that organization select the right project in which to invest capital. Capital Budgeting is intended to help determine the most effective investment decisions for the company, as the ultimate aim is to maximize wealth of the shareholder by acquiring assets. According to Capital Investments (n.d.), “The company ought to decide as to which of the capital investments that are given, would ensure the maximum value to their business and thus they can make their capital investment decision”.

Highest Return on Investment

The highest rate of return, is not necessarily going to be the most effective rate of return, nor the best option for an organization simply because more money is made. More money can lead to a plethora of other factors and actually become more problematic for the company in some situations (e.g. taxes or risks). According to Updegrave (2017), of CNNMoney, states “The higher the return an investment purports to offer, the riskier it’s going to be, even if that risk isn’t immediately apparent”. Higher return on investment only means higher potential risks, simply because a company can make more money on one project over another does not mean it is the most viable or most financially appropriate decision for the company to make.

Factors that Play into Capital Budgeting

Capital budgeting tells financial managers how a company is doing economically. Understanding the capital budget provides a clearer understanding of the financial status of the enterprise and gives financial managers the tools to understand and present the financial health of a company. Capital budgeting deals with investment decisions made over a period of time and is useful in estimation of future benefits from investment proposals. This information can be used in a variety of ways to make sound business decisions.

Capital budgeting contributes a variety of data throughout its process such as formulating long-term strategic goals, estimations and forecast of future cash flows. Factors that contribute to these findings can include the structure of the company’s capital, or their taxation policy. Other areas can aid the capital budgeting process such as availability of funds, and economic value of the project. Additionally, companies need to consider non- quantitative factors when undergoing capital rationing as well. For instance, the company’s culture, environmental concerns, and/or products/services they offer may affect the company’s decisions to undergo a specific investment project.

Dividend Policy

A portion of the company’s earnings earned from investment projects are given back to stockholders that have contributed to the investment project, these are known as dividends. According to Byrd, Hickman & McPherson (2013), dividends are defined as “Payments made to stockholders by the corporations”. Some of the benefits to paying dividends are they are attractive to investors and keep them happy, this could play a huge role in the return of those stakeholders for future investment projects. These stakeholders are basically reinvesting their money which could entice them to return to do it again. Additionally, dividends offer a return on low-risk investments and have the ability to grow, generating more value appealing to investors even more.