IGNOU MCO 7 2017 2018 - Investment decisions and finance decisions are interrelated, comment.

Question

Investment decisions and finance decisions are interrelated, comment.

23 Jan 2018

Answer :

Word Count : 1031

The two decisions boil down to how to spend money and how to borrow money. Recall that the overall goal of financial decisions is to maximize shareholder value, so every decision must be put in that context.

Investment

An investment decision revolves around spending capital on assets that will yield the highest return for the company over a desired time period. In other words, the decision is about what to buy so that the company will gain the most value.

To do so, the company needs to find a balance between its short-term and long-term goals. In the very short-term, a company needs money to pay its bills, but keeping all of its cash means that it isn’t investing in things that will help it grow in the future. On the other end of the spectrum is a purely long-term view. A company that invests all of its money will maximize its long-term growth prospects, but if it doesn’t hold enough cash, it can’t pay its bills and will go out of business soon. Companies thus need to find the right mix between long-term and short-term investment.

The investment decision also concerns what specific investments to make. Since there is no guarantee of a return for most investments, the finance department must determine an expected return . This return is not guaranteed, but is the average return on an investment if it were to be made many times.

The investments must meet three main criteria:

It must maximize the value of the firm, after considering the amount of risk the company is comfortable with (risk aversion).
It must be financed appropriately (we will talk more about this shortly).
If there is no investment opportunity that fills (1) and

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