Investment Decision Analysis

Financial management is concerned with the acquisition, financing, and management of assets. It is the efficient & effective management of money so that company’s objective can be accomplish & it is directly associated with the top management. On these basis financial decisions been made in an organization. Decision function of financial management can be divided in three areas:

• Investment Decision

• Financing Decision

• Asset management Decisions.

Investment Decision

The investment decision is the most important of the firm’s three major decisions when it comes to value creation. It begins with a determination of the total amount of assets needed to be held by the firm. Picture the firm’s balance sheet in your mind for a moment. Imagine

Maximizing earnings per share, therefore, is often advocated as an improved version of profit maximization.

However, maximization of earnings per share is not a fully appropriate goal because it does not specify the timing or duration of expected returns. Is the investment project that will produce a $100,000 return five years from now more valuable than the project that will produce annual returns of $15,000 in each of the next five years? An answer to this question depends on the time value of money to the firm and to investors at the margin. Few existing stockholders would think favorably of a project that promised its first return in 100 years, no matter how large this return. Therefore our analysis must take into account the time pattern of returns.

Another shortcoming of the objective of maximizing earnings per share – a shortcoming shared by other traditional return measures, such as return on investment – is that risk is not considered. Some investment projects are far more risky than others. As a result, the prospective stream of earnings per share would be more risky if these projects were undertaken. In addition, a company will be more or less risky depending on the amount of debt in

Thus this separation of ownership from management creates a situation in which management may act in its own best interests rather than those of the shareholders.

We may think of management as the agents of the owners. Shareholders, hoping that the agents will act in the shareholders’ best interests, delegate decision-making authority to them.

Jensen and Meckling were the first to develop a comprehensive theory of the firm under agency arrangements.1 They showed that the principals, in our case the shareholders, can assure themselves that the agents (management) will make optimal decisions only if appropriate incentives are given and only if the agents are monitored. Incentives include stock options, bonuses, and perquisites (“perks,” such as company automobiles and expensive offices), and these must be directly related to how close management decisions come to the interests of the shareholders. Monitoring is done by bonding the agent, systematically reviewing management perquisites, auditing financial statements, and limiting management decisions. These monitoring activities necessarily involve costs, an inevitable result of the separation of ownership and control of a corporation. The less the ownership