Investing in Assets: Theory of Investment Decision Making

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Abstract

Capital budgeting, or investment decision, depends heavily on forecasts of the cash inflow and a correct calculation of the firm’s cost of capital.1 Given the cost of capital, i.e., the appropriate discount rate, and a reasonable forecast of the inflows, the determination of a worthwhile capital investment is straightforward. An investment is desirable when the present value of the estimated net inflow of benefits (or net cash inflow for pure financial investments) over time, discounted at the cost of capital, exceeds or equals the initial outlay on the project.