Behaving better with stock options

286 Part IV: Anticipating Surprises: Risk and Uncertainty

Investment requires long-term decisions. You spend/invest money and incur a cost today in order to realize future revenue. Although they’re always longterm, investment decisions address different purposes and have different affects on the firm. Investment purposes include the following:

✓ Replacement investment decisions are expenditures to replace existing machinery and equipment. A restaurant deciding to replace kitchen equipment and a firm replacing assembly line machinery are examples of replacement investment decisions. ✓ Modernization investment decisions reduce production costs. A modernization decision emphasizes more efficient operation — it may involve the renovation of a factory or the installation of automated machinery. ✓ Expansion investment decisions increase the firm’s productive capacity or introduce new products or markets. A firm’s decisions to build an additional factory or expand sales to a new region are examples of expansion decisions. ✓ Operating investment decisions involve changes in inventories.

Economists regard inventory as an investment because inventory represents goods produced but not immediately sold. A car dealer may increase the number of cars it keeps to interest new customers. ✓ Seed investment decisions represent investment expenditures whose returns aren’t immediately realized. Typical seed investment decisions include expenditures into research and development, training, market research, and advertising. ✓ Pollution-control or safety investment decisions include investments necessary for compliance with regulations established by government agencies such as the Environmental Protection Agency (EPA) and the

Occupational Safety and Health Administration (OSHA). In addition, investments related to worker safety may be required by labor agreements or insurance policies.

Each type of investment decision represents an immediate cash outlay for some future revenue or benefit.

Selecting among Alternative Investments

You face a variety of investment opportunities at any given point of time; therefore, it’s important to develop criteria that enable you to choose among these projects. Determining which projects to undertake during a given period determines your firm’s current capital expenditures. In addition, the projects selected influence your firm’s future operations and profit.