In making investment decisions, various factors must be considered. Managers have to know that the success of the business entirely depends on how best the investments are analyzed before they are undertaken. First, capital budgeting requires large capital outlay (Dugdale 16). Most of the capital budgeting decisions require a large proportion of business funds. It, thus, implies that failure to make proper investment decisions will lead to losses for the organization. Secondly, investment decisions are irreversible. After deciding on what projects to invest in, managers will lack the ability to reverse their decisions, i.e., equipment once acquired cannot be easily disposed of. The managers must therefore be careful before settling on a particular investment projects because of this nature.
Moreover, in analyzing investment, the future cash flows are of importance. The cash flows likely to arise to the organization after determining which projects to invest will be realized in the future. The cash flows cannot be determined with certainty and therefore depend on forecasts and future changes in conditions (Szpiro 53). Managers will use their skills in forecasting future cash flows and in evaluating the worth of the investments. Capital budgeting needs long time decisions and commitments.
Various models are used in evaluating the investments to pursue by the organization. These can be largely categorized into two: non-discounted methods and discounted methods of capital budgeting. The non-discounted method include payback period in which the period required to recoup the capital invested is used. Projects with a short payback period are preferred. The return on investment is the second non-discounted method of project evaluation. In this method, projects with the highest returns are chosen for investment purposes. This method is pegged on the historical accounting estimates.