Making investment decisions is one of the most important responsibilities for financial managers. These decisions often involve purchasing expensive long-term assets that will be used for many years. As a result, capital investment decisions are considered long-run decisions that will determine the future success of a company. There are several reasons why investment decisions have long time horizons.
Investment decisions require forecasting long-term cash flows
When analyzing a potential investment, managers must forecast the project’s cash flows over its entire useful life, which could be 5, 10, or even 20 years into the future. The further out the projections, the greater the uncertainty. But long time horizons are necessary to fully capture the costs and benefits of major capital investments.
Investments in long-lived assets tie up capital for years
Major investments like new plants, equipment, and technology infrastructure often have very long useful lives. This ties up the company’s capital for many years. Redeploying these assets to other uses is usually difficult as they are customized and illiquid. Therefore, investment decisions commit the firm’s scarce resources for long periods.
Long horizons are needed to realize strategic benefits
Although investment decisions consider quantitative factors like NPV and IRR, they must also align with a company’s long-term strategic goals. Investment projects can enable expansion into new markets, improvements in production efficiency, and strengthened competitive advantages. But these strategic benefits often take many years to fully materialize.
Investment decisions shape the firm’s future capabilities
Capital investments in areas like R&D, new technologies, and employee skills development are crucial for building a company’s capabilities over the long run. Major investments today allow a firm to tap into future opportunities and adapt to market changes. While the upfront costs are high, the long time horizon is key to reap the rewards.
In summary, capital investment decisions require long time horizons given the need to forecast distant cash flows, the long lives of assets, the delayed strategic gains, and the goal of shaping long-term capabilities. Carefully evaluating where to commit resources today is vital for a firm’s competitiveness and profitability well into the future.