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The investment decision — also called capital budgeting — is about choosing which long-term assets and projects to commit capital to. This is the most consequential decision: it determines the company's future cash flows and ultimately its value.
The guiding principle: invest only in projects that are expected to create value for shareholders — that is, where the return exceeds the cost of the capital deployed.
Key tools used to evaluate investment decisions: - NPV (Net Present Value): accept if NPV > 0. - IRR (Internal Rate of Return): accept if IRR > cost of capital. - Payback period: recover the investment within an acceptable timeframe.
Investment decisions affect the left side of the balance sheet — they determine what assets the firm holds and what cash flows those assets generate. All other decisions are secondary to getting this right.
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Why is this the correct answer?
Eliminate any option that contradicts something stated directly in the lesson, then check which one actually follows from the rule you just learned. Tell me which option confused you and I'll point to the exact line.
Exam strategy
DCF questions turn on the discount rate — higher risk = higher rate = lower NPV. IRR and NPV agree on accept/reject but can rank projects differently.
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