Working Capital

Introduction

Investment is the sacrifice of current liquidity or current rupees or current dollars for future liquidity, future rupees or future dollars. There are different concepts and types of investment. In detail, these concepts and types of investment are dealt in this lesson.

Concepts of investment

There are two concepts of investment, viz, the economic concept and the financial concept.

The economic concept of investment refers to investment as "expenditures on new plants, machinery, capital equipment and so forth, with the hope of making added wealth". To make added wealth, the rate of return on the investment must be more than the real cost of capital. Suppose, one estimated that his investment in the above referred to assets is giving him a real of return of 15.5% p.a. and his nominal cost of capital is 20% inflation being 10%. The real cost of capital is given by nominal cost - inflation rate = 20% - 10% = 10%. Then, the investor makes a net wealth addition to the extent of 1(1 + r) / (1 + K*) -I, where I = original investment, r = real rate of return and K* = real cost of capital. If we assume an I = Rs. 100 mn, then

Wealth addition = Rs. 100 mn (1 + 15.5%) / (1+10%) - Rs. 100 mn

= Rs. 100 mn (1.155) / (1.1) - Rs. 100 mn

= Rs. 105 mn-Rs. 100 mn = Rs. 5 mn

The economic concept of investment is wealth creating oriented and that depends on Return on investment (r) and real cost of capital (K *). Only if r > K * wealth addition result. If r = K *, neither wealth addition nor wealth depletion results. If r < K *, wealth depletion takes places.

The financial concept of investment refers to investment as, "commitment of funds in financial assets with the hope of getting current income in the form of dividend or interest and / or capital gain:. It is nothing but sacrificing certain present consumption for a hoped for enhanced future consumption. Put otherwise, investment is postponement of consumption. That is "savings" are considered as investment. Savings can be in any form. A farmer produces 100 bags of paddy, but consumes only 40 bags of paddy and difference is his savings and hence his investment. A salaried employee earning Rs. 2 lakh p.a. and his consumption expenditure is Rs. 1.5 lakhs and hence his savings Rs. 50,000 amount to investment which may be in the form of undrawn bank balance, shares, debentures, gold, National Savings Certificates Etc.

Goals of Investment Whatever may be the nature of investment, whether it is economic or financial, it has lot of motives. They are as follows:

1. Get decent current income

2. Obtain reasonable capital gain

3. Benefit from tax-off

4. Right to participate in growth

5. Reduce risk, given overall return

6. Maximize return, given risk

7. Ensure safety of investment

8. Provide for liquidity of investment

9. Easy transferability

10. Preference of pledgeability

11. Protection for future

12. Beat the inflation

13. Sense of participation in national economic development

14. Fulfillment of security, social and esteem needs

15. Economic power

Let us explain each of these goals to an extent.

Get decent current income

Current income is the periodic (monthly, quarterly, semi-annual or annual) return in the form of interest or dividend or party-pay back. Usually debt investments or some mutual funds or some life policies give/guarantee periodic income. Shares of companies with unbroken dividend income.

Current income is surer than future income, as it is analogous to "a bird in hand", as against "two in the bush". Current income is desired by risk-averters, small investors, income mutual funds and such featured investors. Tax benefit u/s 80L is available for current income.

Obtain reasonable capital gain

Capital appreciation is net value addition. If it is available in addition to current income, it is double welcome for investors. Tax benefit u/s (48(2) is available for capital gain, after indexation for inflation. Capital gain is bit riskier as it involves a peep into the future which is beset with uncertainty and risk. Shares in growth companies, good turnaround shares, shares in leveraged buy-outs, shares in successful venture schemes, convertible debentures in blue-chips, global depository and American Depository receipts of growth concerns, zero coupon bonds, deep discount bonds, growth mutual funds, etc promise capital gain. Big investors and risk-seeking investors, prefer capital gain to current income.

Benefit through tax-off

Investors prefer tax-benefit coated investments. Income Tax Act Provisions 80L and 48(2) give tax concessions for current and capital incomes respectively. Besides, tax benefit on investment committed is also available. U/s 88 of the IT Act, investments in NSC, NSS, 10/15 years P.O. savings schemes, LIC policies, Mediclaim policies, PF, PPF, SPF, GIS, equity-committed mutual funds schemes, investment in self-occupied house property to the extent principle repaid, limited to Rs. 10,000 at the maximum out of income, on loans taken for house construction, etc. qualify for tax rebate. Salaried employees in India find this tax-benefit really alluring. The one exception is equity related mutual fund schemes which have not gone fads. There are no investors, and hence no floaters, of late.

Pre-emptive right to participate in growth firms

If a blue-chip company goes to expand, the additional fresh equity capital required to fund expansion is first sought from existing shareholders, giving them a chance to participate in the company's growth. The shares are issued at discount to market price and that for existing shareholders such "right" offers, are real bonanza. One has to be at least a moderate sized investor, if not big, to benefit from right offers. Of course, rights can be sold in full or part and that all shareholders can benefit. To "right" holders capital gain results, as well as current income, as their