Firms continually invest funds in assets and these assets produce cash flows and income, which can be either reinvested or paid to the shareholders. These assets represent the firms capital and is the firm's total assets and includetangible and intangible assets. Capital investment is the firm's investment in its assets. The firm's capital investment decision may be comprised of a number of distinct decisions each referred to as a project. A capital project is a set of assets that are contingent on the other and are considered together.The investment decisions of the firms are decisions concerning a firm' s capital investment.Investment decisions of capital projects are primarily based on two factors:
(i) the changes in the firm's future cash flows by investing in a particular capital project, and
(ii) the uncertainty associated with future cash flows.
The value of a firm is the present value of all its future cash flows and the source of these future cash flows are:
Assets that are already in place
• Future Investment Opportunities
Future cash flows are re-discounted at a rate that takes into consideration the risk and uncertainness of these cash flows. Cash flow risk comes from two basic sources:
Sales risk, which is the degree of uncertainty related to the number of units that will be sold and the price realised.
Operating risk, which is the degree of uncertainty concerning cash flows that arises from the particular mix of fixed and variable operating costs of sales. Risk is associated with general economic conditions prevailing in the markets in which goods and services are sold, whereas the operating risk is determined by the product itself and is related to the sensitivity of operating cash flows to changes in sales. The combination of these two risks is business risks.
The discount rate (the rate of return required to compensate the suppliers of capital) is a function of business risk associated with the project. From the investors perspective the discount rate is the required rate of return (RRR) and from the firm’s perspective, the discount rate is the cost of capital.
(i) the changes in the firm's future cash flows by investing in a particular capital project, and
(ii) the uncertainty associated with future cash flows.
The value of a firm is the present value of all its future cash flows and the source of these future cash flows are:
Assets that are already in place
• Future Investment Opportunities
Future cash flows are re-discounted at a rate that takes into consideration the risk and uncertainness of these cash flows. Cash flow risk comes from two basic sources:
Sales risk, which is the degree of uncertainty related to the number of units that will be sold and the price realised.
Operating risk, which is the degree of uncertainty concerning cash flows that arises from the particular mix of fixed and variable operating costs of sales. Risk is associated with general economic conditions prevailing in the markets in which goods and services are sold, whereas the operating risk is determined by the product itself and is related to the sensitivity of operating cash flows to changes in sales. The combination of these two risks is business risks.
The discount rate (the rate of return required to compensate the suppliers of capital) is a function of business risk associated with the project. From the investors perspective the discount rate is the required rate of return (RRR) and from the firm’s perspective, the discount rate is the cost of capital.
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