nvestment decisions can be classified in many different ways. We will highlight one of these classifications, the one that dictates the following types of investment decisions:
- Existing business expansion.
- New business expansion.
- Modernization and replacement.
According to Sun Capital Partners CO-CEO, Marc Leder, here is what you need to know about these investment choices.
Diversification And Expansion
The company can add extra capacity to the product lines that already exist or can expand the existing operations. As an example, a company can increase capacity in order to manufacture more of a specific product. This practically means related diversification. The firm can expand activities in what is practically a brand new business. Investments are needed for such a change inside a firm.
When a manufacturing company puts money into opening a brand new plant and buys new machinery, something that the firm never did before, it is unrelated diversification. In some cases, the company can buy an existing firm, of course. No matter the case, the expectation is to add revenue. Investing money in new or existing products is needed in many cases and is sometimes known as revenue expansion investment.
Modernization And Replacement
In this case, the main objective of the investment is to reduce operating costs and increase efficiency. Cost savings will reflect in automatic profits increases, even if revenue remains the same.
Many assets end up being obsolete and outdated because of technological changes. A company has to decide when and if to replace assets with some that are better to operate from an economic point of view. For instance, if we have a garment company that changes operations from the semi-automatic washing equipment to something that is fully-automatic, we have replacement and modernization.
Decisions related to replacements are important since they introduced more economical and efficient assets. Oftentimes, such decisions are difficult and substantial amounts are involved.
Other Investment Decisions Classifications
As already mentioned, there are many other ways to classify the investment decisions you make. We should also talk about:
- Mutually exclusive investments – These are type of investments that have the exact same purpose and that actively compete. When an investment is chosen, there are other investments that are excluded.
- Independent investments – These are serving different purposes and never compete. As an example, the heavy engineering company can expand the plant capacity in order to build extra excavators and brand new production facilities for the creation of lighter commercial vehicles. Based on funds availability and profitability, both investments can be considered.
- Contingent investments – These are dependent projects, basically choosing investments based on other investments. As an example, if you want to build a new factory in an area that is remote, it might be needed to also invest in roads, houses, hospitals and more. In order to attract workforce, the company has to invest in employee facilities. Total expenditure, in this case, is normally seen as just one investment.
Investment decisions are complicated, as you already saw. Much more can be said about the topic so be sure that you learn the theory before you actually make an investment.