Israel has said it is considering military strikes on Iran's nuclear sites if the Islamic Republic does not resolve Western fears it is developing atomic weapons technology, something Tehran denies.
Iran says it could hit Israel and U.S. bases in the region if it comes under attack. It has also threatened to block the Strait of Hormuz, the neck of the Gulf through which 40 percent of the world's sea-borne oil exports pass.
"With the fourth generation of the Fateh 110, the armed forces of our country are able to target and destroy land and sea targets, enemy headquarters ... missile seats, ammunition sites, radars and other points," Defence Minister Ahmad Vahidi said in quotes carried by the official IRNA news agency.
The missile has a range of around 300 km (180 miles), meaning it could strike Iran's immediate neighbours and might also be able to hit Hormuz shipping, as well as energy facilities in Saudi Arabia and the U.S. fifth fleet in Bahrain.
Such moves would risk a military response from the United States.
"Using new guidance methods, target-striking systems were installed on the missiles and during the flight test ... its ability to hit the target without deviation was proven," Vahidi said, according to IRNA.
"In future programmes, all future missiles built by the Defence Ministry will be equipped with this capability," he added.
Iran has made "robust strides" in developing its ballistic missile capabilities, the London-based International Institute for Strategic Studies wrote in a 2010 assessment which also said that Iran's arsenal suffered from poor accuracy.
All of Tehran's ballistic missiles would be capable of carrying a nuclear payload, the IISS said.
Last month, Iran said it had successfully test-fired medium-range missiles capable of hitting Israel, and tested dozens of missiles aimed at simulated air bases.
It conducted what it called the "Great Prophet 7" missile exercises at the start of July as a European Union embargo on Iranian crude oil took full effect.
Those sanctions, in addition to measures against Iranian banks and U.S. efforts to persuade countries around the world to cut economic ties with Iran are aimed at forcing the Islamic Republic to make concessions on the nuclear work it says is for purely peaceful ends.
"The test firing of the missile is most likely to be a warning to the West and Iran's Persian Gulf neighbours that Iran too can escalate the level of tensions in the Persian Gulf area," said Meir Javedanfar, Iran expert at the Interdisciplinary Center in Herzliya, Israel.
Bruno Gruselle, senior research fellow at the Foundation for Strategic Research in Paris, said any improvements in the accuracy of Iran's short-range missiles might be a precursor to better long-range ones.
"Fateh is a very short range guided rocket and a good platform to test improved guidance," he said. "They will have to take that to longer range systems which have very different mechanical constraints during their flight, but they will obviously work on that."
Vahidi said the missile was intended as a defensive weapon. "These capabilities are defensive and would only be used against aggressors and those who threaten the country's interests and territorial integrity," he said.
The former head of Israel's intelligence service Mossad Efraim Halevy on Thursday said on Israel Radio he "would be very worried about the next 12 weeks," if he were Iranian.