The company’s chief also stated that this is done to increase the value of business for shareholders and to utilize the cash which is lying idle. The article is about financial management, because according to the fundamental principle, any cash lying idle is decreasing its future value. Therefore, all cash must be earning some returns too keep up with the future value.
On the other hand if you look at the article critically, there are some weak arguments in it. When the firm says that it want to diversify to spread the risk, it should be aware that recession hits all the business and they may not be able to cover the losses. Similarly, firm will also have to make deep analysis about the future value of their investment. They cannot just invest in anything but they should make sure that they investing at the right place where the firm is not using future value of their cash, in other words, returns on this investment or profits should be greater than inflation rate in the country. Only this way future value of their money will remain stable and writer should have discussed this point in his article.
If you have been able to crack a continued trend in the market about inflation rate and interest rate, you should adjust your capital spending on the basis of these. You should always go for those assets which are going to give you more return than inflation rate. …
you 12% returns whereas inflation rate in your country is 13%, then you should not buy this assets because you will be 1% worse off or your money value will be decreasing over time. Similarly, you should go for those assets which are giving you returns of more than the inflation rate and in this way purchasing power of money will not be deteriorating.
Similarly, you should borrow money to invest in capital expenditure, only if it is deemed that you’ll get more returns than the interest rate. If you buy an asset giving you 5% return whereas you have borrowed money at the rate of 8% then you will not be benefiting from that purchase but instead you will be losing money.
So, identifying the market trend, it is imperative that all capital spending should be linked with inflation and interest rate. Such expenditures should only take play if the returns of this spending are greater than the forecasted inflation and interest rate.
James Pethokoukis, Reuters, Written on 10 June