Processes and Problems of Making a Domestic Capital Investment Decision

Introduction

Decision making while making an investment is considered to be an essential part of the strategic decision making in every single enterprise as the newer investments in every project is bound to affect the economic results of the future and the prosperity of the enterprise. Success of the enterprise contributes dramatically for the growth of the efficiency of the enterprise. The failure of the enterprise leads not only to the possible decline of the efficiency of the enterprise, but can also endanger the existence of that particular enterprise. Success and the failure of the enterprise largely depends on the quality of the preparation and evaluation of such projects. The quality of the decision making while making an investment can affect large number of factors as most important of them include the choice of criterion which are applied in the evaluation and choosing the projects while making an investment.

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Being an investor, one would like to beat the market effortlessly, selling and buying the investments which are based on perfect timing, a little luck with a blend of instinct. The investor, however, knows the task is not easy. While it might feel as hard to plan, the process of investment is considered to be the workhorse behind every sustainable strategy for investment. This is due to the fact that an orderly way for the creation and the maintenance of a portfolio, which is aligned with specific objectives and goals to manage the risk in investments, is provided by the investment process. For the investors, it is required to understand the process of investment due to different reasons, which include,

1. The steps which are required in the creation of investment portfolio, along with the sequence of
   actions which are involved from defining the risk patterns to asset the allocations, due diligence,
   selection of investment, buy or sell discipline, evaluation of performance along with other
   critical factors.
2. For the implementation of a strategy, a structure is provided which is nurtured for the specified
   objectives, goals, risk tolerance, timeframe which seek the management for the risk overtime.
3. A framework is established for the evaluation of the investor’s strategy and tracking the progress
   for the goals.

There are two ways investment can be made in a certain project or a company, with the diversified or without diversified assets. These two have their own perks and can either help the investor in retaining a particular investment or fail the investor by completely bankrupting the investor. Considering the types of investments, there are two types in which they can be divided including domestic and foreign investments.

Making Domestic Capital Investment Decision – Investors with No Diversified Assets

• Process

Domestic Capital Investment means investing capital domestically i.e., in the same country. For investing in the same country there are certain risks which are required to be followed. These risks are always needed to be taken into consideration and the successfulness of the investor solely depends upon the factors associated with these factors. These factors belong to the Policy Framework for Investment (PFI), consisting of a systematic approach for the assessment of the investment and the business climates, and for the design of the reforms for improving them. This framework involves eight policies, which are necessary for the investor with no diversified assets. An investor, investing and has non-diversified assets is at a huge risk losing the entire invested capital if the enterprise fails. Investing with non-diversified portfolio means investing in the same field or prospect. This can be clearly simplified through an example i.e., if an investor has invested in both the airline and the train sector, then with the failure of one sector, the other sector is one to fall along with it. With both the sectors falling in the same category, the risks associated with both of the sectors are the same. If the fuel prices rise up, there is a maximum chance that this will affect both the industries with the after effects felt by the investors in these particular fields as well. Hence, the investors need to take great care while investing in the similar sectors or in other words, with the non-diversified assets. So, the investors with non-diversified assets have no option but to follow this policy (PFI) for achieving the desired results from their investments while making a domestic investment. The factors influencing the process of domestic investment by the investor with non-diversified assets correspond to the ten policies belonging to the PFI, which include,

1. Investment Policy: The investment policy of a country or region is needed to be taken into consideration by the investor for making a successful investment in a particular area or a region. Within each country, each area or a region holds certain rules and regulations pertaining to the amount of capital to be invested in that particular area. This can impact the amount invested by the investor and the corresponding profit (Rugman and Verbeke, 2017). Hence the investor, especially with non-diversified portfolio require taking great care with the policies to be followed as the entire capital is at stake.

2. Management Outlook: The investor during the investment needs to make sure that wherever the investment is being made is managed perfectly so that there are no flaws whatsoever with the finances invested in a particular company or an organization. This also provides the investor with the broader image of the success of the company which is chosen by the investor, making the investment safer and helping the investor by analysing the progression which will be earned by the investor based on the capital which is invested. Sustainability of a company or an organization is also based on the management involved with handling the finances invested within a particular company or an organization. If the management is progressive and has an aggressively growth and marketing outlook, the capital proposals and innovation would be favoured and encouraged, ensuring better productivity on the quality or both. In some of the industries where the manufactured product is considered to be a simple one, there is a difficulty in innovation and the cost consciousness of the management prevails. However, for the electronic and chemical industries, the survival of a firm is not possible if the policy of ‘make-do’ is followed using its existing equipment. The innovation and the progressiveness of the management is necessary and should be encouraged in such a case.

3. Strategy for Competitors: There is a significant influence on the decisions, regarding the decision of investment taken by a company, exerted by the strategy for competitors towards the investment of capital. If there is tendency for the competitors to install greater equipment, producing products constituting a greater set of variety and better quality, the existence of the company would be in extreme danger. Hence, the policies related to investment of a particular company are often influenced due to the policy of a rival company towards the investment of capital in a particular area or a field, forcing the decision on that particular company.

4. Technological Changes and Opportunities: Newer equipment is created by the changes in technology which might represent a major change in the process, such that there is an emergence for the need of re-evaluation of the capital equipment which already exists in a company. New investments might be justified by some of the changes, which include the replacement of the older equipment which is replaced by the new and improved equipment, due to the technological innovation. This also involves the downgrading of the older equipment to some other applications.

There is a need for proper evaluation of this aspect, as this aspect is not often taken in to consideration. In this particular respect, we may consider that there is a great need for the analysis of the cost of equipment being one of the main factors in the investment decisions. The management, however must take into consideration the incremental cost, and not the entire accounting cost of the newer equipment as the cost of new equipment is partly offset by the replaced equipment’s salvage value. The index in such an analysis is called the disposal ratio, and becomes relevant in such studies.

5. Market Forecast: Both the long- and short-term forecasts of the market are considered to be the influential factors in the decisions related to capital investments. For the participants in a business to survive in a long-run forecast for the critical decisions of the market potential on the capital investment have to be taken (Alexander, 2001). The investors need to take great care while moving forward with any domestic investment as the fluctuating market can completely drown an investor and the invested capital if not taken in proper consideration.

6. Analysis of Fiscal Incentives: Concessions on taxes imposed on either income obtained from newer investments or the allowance for the investment which is allowed on the newer decisions of investments, the method which allows the allowance based on depreciation deduction is also responsible in influencing the investment decisions of an investor. For studying the fiscal incentives, an investor needs to analyse the market and the taxations involved for investing in a particular field corresponding to the area where the investor is interested to invest in.

7. Cash Flow Budget: Analysing the cash flow budget provides the investor with the flow of funds, which come in and go out of the company, affecting the decisions related to the capital investment in two ways. The first way includes an analysis for the indication necessary required case for buying the desired equipment, not immediately but maybe, after a year, showing the purchase of the capital assets to generate the required demand for the necessary capital additions after approximately two years, with such expenditures clashing with the anticipated other expenditures which could not be postponed. The second way is that for the alternate investments, the time for the cashflow is calculated through the cash flow budget, helping the management in the selection of the desired project for investment.

8. Non-Economic Factors: The newly updated equipment might be able to improve the environment of the workplace and help in promoting more socialization in a particular job. Socialization is an important factor influencing increased productivity (O’donoghue, 2017). The evaluation of the benefits in the monetary terms might be difficult, and we may call such factors as the non-economic factors affecting the productivity as a result of investing capital in your own or someone else’ company.

• Complications

The main problem with an investment by the investor with no diversified assets is the risk involved in investing in a single area or division of the market. Though there is a probability of a possible return on investment, with a large amount of profit, as the entire money of that particular investor has been invested in a specific firm, resulting in greater yield. The profits, though greater than the one generated through the diversified assets, which means that the investor invests in more than one area of the market, there is also a huge risk involved, as if the investor has invested the entire money in one area of the market and the area of investment fails, the resultant investment also fails and the investor loses all of the invested money. However, for the investor with diversified assets, as investment takes place in more than one area of the
market, the chance of losing all of the money lowers down, as if the investor loses the invested capital due to the loss in one area, there is a chance this loss would be compensated with the profit calculated from the other area of the market where that investor has invested.

For the Company to be Taken Over by a Diversified Owner

The change in the answer would only be based on the general rule for investment in any market i.e., diversification is necessary. It is important that the diversification, when it comes to investing the assets or the capital of the company in a diversified way, such that if one area of investment fails, the other one helps with the investment and helps the investor by retaining the profits from the other areas of the market where that investor has invested the capital. The international investment corresponds to the two types of investments, which include the Foreign Direct Investor (FDI) and the Foreign Institutional Investor (FII). The FDI means the investor who invests in a foreign country directly, which might be in the form of a manufacturing plant or something similar, providing jobs and based on the concept of long-term investment
(Alfaro et al., 2004). While the FII corresponds to the investors who invest in the public institutions or by investing in bonds, corresponding to the idea of a short term investment and producing the profits in a shorter term as compared to the FDI (Jain et al., 2012). For the international investment, three types of market are to be considered,

1. Developed Markets: The developed markets constitute of large, economies which are industrialized. The economic systems of the developed markets are well developed. The rule of law and the political stability is the main essence of such markets. The markets which are developed are considered to be the safest destinations to invest, but the rate of economic growth usually trails behind the countries with the market which are in the early developmental stages. The analysis of the investment of the markets which are developed usually takes into account the current cycles of the market and economic growth. The importance of the political consideration is negligible.

2. Emerging Markets: The emerging markets are those which illustrate higher levels of the economic growth with a rapid rate of industrialization. The stronger economic growth can sometimes boost the returns in investment which are superior to those which are available in the developed markets. But the emerging markets are also considered to be risky as compared to the developed markets. The uncertainty in politics in the emerging markets often lead the economies to be more prone to the busts and booms. Along with the careful evaluation of the financial and the economic fundamentals of the emerging market, a close attention to the political climate of the country is to be provided by the investors, with the often-unexpected political developments affecting the market and shape shifting the economic aspects of the particular market.

3. Frontier Markets: These markets are responsible in presenting the next wave of the destinations for investment. Such markets are either small, in comparison with the traditional emerging markets, or are considered to be found in such countries where there are bans which place certain restrictions against the ability of the foreigners to invest. Even though such markets can be extremely risky, with a greater chance of suffering from the low liquidity, these markets also offer the potential for the returns, exceeding the expectations through the time. Frontier markets do not correlate well with the other destinations boosting the traditional investments, which means that benefits related to the additional diversification are provided, while being held in the well-rounded investment portfolio. The Frontier market’s investors must also observe the political environment of the market, along with the financial and economic developments. Before investing in a foreign country either with or without diversified assets, certain risks are to be estimated which include,

1. Economic Risk: The Economic Risks refer to the ability of the country to payback its debts, such that the country with the stronger economy and stable finances would provide greater reliable investments as compared to a country which has weaker finance department or crumbling economy.
2. Political Risk: This term refers to a country’s political decisions, which might result in the unexpected loss to the investors. As the economic risk is considered to be the ability of the country to payback its debts, the political risk is often referred as the willingness of the country towards paying the debts or maintaining the necessary hospitable climate, welcoming the foreign investment and foreign investors to that particular country. If the political climate is not friendly, the country is not considered to be a good place for investment even if the economy of the country is strong.
3. Sovereign Risk: This risk revolves around the risks associated with the foreign central bank, with this foreign central bank capable of altering the foreign exchange regulations of a country, significantly nullifying or reducing the value of its contracts related to the foreign exchange. The analysis of the sovereign risk factors is beneficial for both the bond investors and the equity. When investing in the equity of the specific companies within the foreign country, a sovereign risk analysis can help in the creation of the macroeconomic picture of the operating environment, but the bulk of the analysis and the research would be required to be done at the company level. On the contrary, if the investment is done directly in the bonds of the country, the evaluation of the economic condition and strength of the country can be a better way for the evaluation of the potential investment in bonds.

Conclusion

The diversified assets are the key to a successful investment. A successful investor does not consider investing the entire capital in a single area of the market or a single venture, which is a highly risky step. The loss for such an investment results in the loss of the entire capital invested by such an investor, while the investor with the diversified assets considers investing in more than a single area of the market, which doesn’t provide as much of a profit if both the types of investors are successful, but is highly secure as compared to the investment made in just a single area of the market or venture or a company. For both domestic and foreign investment, there are certain factors which must be studied as the capital of the investor is at stake, and the fulfilment of those factors is necessary considering a certain capital investment as safe for the investor.

References

• Alexander, C., 2001. Market models: A guide to financial data analysis. John Wiley & Sons.
• Alfaro, L., Chanda, A., Kalemli-Ozcan, S., Sayek, S., 2004. FDI and economic growth: the role
  of local financial markets. Journal of international economics 64, 89–112.
• Jain, M., Meena, P.L., Mathur, T.N., 2012. Impact of foreign institutional investment on stock
  market with special reference to BSE, a study of last one decade. Asian Journal of
  research in banking and finance 2, 31–47.
• O’donoghue, M., 2017. Economic dimensions in education. Routledge.
• Rugman, A., Verbeke, A., 2017. Global corporate strategy and trade policy. Routledge.