Question

Investment Decisions

All investment decisions involve a certain degree of risk and uncertainty. How can a manager reduce the level of risk and uncertainty when making CapEx decision? In your response explain how Economic Value Added (EVA) may help reduce this uncertainty.

Answer 1

Capital Investment decision is very crucial as it carries variant risks & uncertainities.Capital expenditures are incurred by company for acquiring long life assets which will be benifiting the company for a long time.The objectives of capital investments is to accelerate the growth.Few steps to be taken by the decision maker to mitigate the risks & uncertainities are :

1) Assessment of current or existing risks instead of evalauting a new project.

2)Once the manager is able to find out the current risks , he shoud then focus on drilling down on risks in their proposed projects and eliminate the need—and the temptation—to adjust net present value (NPV) or risk premiums arbitrarily.

3) Choose less cost intensive project at first.

4)Stop unnecessary market exposure.

5)Minimize Timing Risks.

6) Maintain the consistency of Annual Cappex for a long term.

7.Divide large projects into smaller ones.

Economic Value Added may help to reduce the uncertainities.EVA is a top to down analysis for risk management.The expanation is given below:

1) EVA is a good controlling device in a decentralised enterprise.EVA can be applied to find out EVA contribution of each de-centralised segment of the company.

2)EVA helps to maximize the Shareholder's wealth & it keeps the the managers to maximize the sme.

3)EVA is a good parameter for the Investors .Investors can assess any company by using this tool.

4)It helps to improve the Goodwill of the company.