The Misapplication of Capital Investment Appraisal Techniques
The misapplication of capital investment appraisal techniques
Drury, Colin, Tayles, Mike. Management Decision. London: 1997. Vol. 35, Iss. 2; pg. 86
Abstract (Summary)
An examination of the surveys of capital budgeting practices that have been undertaken during the past 20 years in both the UK and US reveals a trend towards a continuing increase in the use of more sophisticated capital budgeting techniques. In a longitudinal survey of capital budgeting practices of large UK companies between 1975 and 1992, substantial increase in the usage of discounted cash flow (DCF) and risk appraisal techniques was reported. Despite the increased usage of the more theoretically sound discounting techniques, several writers in both the UK and US have claimed that companies are underinvesting because they misapply or misinterpret DCF techniques. It has been asserted by several writers that firms are guilty of rejecting worthwhile investments because of the improper treatment of inflation in the financial appraisal. Many firms are understating NPVs and IRRs because of the incorrect treatment of inflation and the use of excessively high discount rates. Concern has also been expressed by various commentators that many companies are failing to invest in advanced manufacturing technologies (AMT) as fully as they should. Financial appraisal techniques have been cited as a major reason for the under-investment in new manufacturing technology. DCF procedures should not be ignored or relegated in importance merely because they might be used incorrectly. Instead, decision-makers should recognize potential problems and be careful to ensure that the financial appraisal is performed correctly.
» Jump to indexing (document details)
Full Text (5565 words)
Copyright MCB UP Limited (MCB) 1997
Colin Drury: Professor, University of Huddersfield, Huddersfield, UK
Mike Tayles: Lecturer, University of Bradford, Bradford, UK
ACKNOWLEDGMENT: Financial support for undertaking
Drury, Colin, Tayles, Mike. Management Decision. London: 1997. Vol. 35, Iss. 2; pg. 86
Abstract (Summary)
An examination of the surveys of capital budgeting practices that have been undertaken during the past 20 years in both the UK and US reveals a trend towards a continuing increase in the use of more sophisticated capital budgeting techniques. In a longitudinal survey of capital budgeting practices of large UK companies between 1975 and 1992, substantial increase in the usage of discounted cash flow (DCF) and risk appraisal techniques was reported. Despite the increased usage of the more theoretically sound discounting techniques, several writers in both the UK and US have claimed that companies are underinvesting because they misapply or misinterpret DCF techniques. It has been asserted by several writers that firms are guilty of rejecting worthwhile investments because of the improper treatment of inflation in the financial appraisal. Many firms are understating NPVs and IRRs because of the incorrect treatment of inflation and the use of excessively high discount rates. Concern has also been expressed by various commentators that many companies are failing to invest in advanced manufacturing technologies (AMT) as fully as they should. Financial appraisal techniques have been cited as a major reason for the under-investment in new manufacturing technology. DCF procedures should not be ignored or relegated in importance merely because they might be used incorrectly. Instead, decision-makers should recognize potential problems and be careful to ensure that the financial appraisal is performed correctly.
» Jump to indexing (document details)
Full Text (5565 words)
Copyright MCB UP Limited (MCB) 1997
Colin Drury: Professor, University of Huddersfield, Huddersfield, UK
Mike Tayles: Lecturer, University of Bradford, Bradford, UK
ACKNOWLEDGMENT: Financial support for undertaking
References: 2. Dimson, E. and Marsh, P. (1994, "Unhappy returns", Financial Times, 9 February. 3. Finnie, J. (1988, "The role of financial appraisal in decisions to acquire advanced manufacturing technology", Accounting and Business Research, Spring, pp. 133-9. 4. Hayes, R.H. and Garvin, D.A. (1982, "Managing as if tomorrow mattered", Harvard Business Review, May-June.. 5. Hodder, J.E. and Riggs, H.E. (1985, "Pitfalls in evaluating risky investments", Harvard Business Review, January-February, pp. 128-35. 6. Kaplan, R.S. (1986, "Must CIM be justified by faith alone?", Harvard Business Review, March/ April, pp. 87-95. 7. Klammer, T. P. and Walker, M. C. (1984, "The continuing increase in the use of sophisticated capital budgeting techniques", California Management Review, Fall, pp. 137-48. 8. Marsh, P., Barwise, P., Thomas, K., Wensley, R. (1988, "Managing strategic investment decisions in large diversified companies", in Pettigrew, A. M. (Ed.), Competitiveness and the Management Process, Blackwell, Oxford, 1988. 9. New, C. (1985, "Manufacturing: competitive edge or corporate milestone?", Paper presented to BPICS Conference, October. 10. Pike, R.H. (1985, "Owner-manager conflict and the role of the payback method", Accounting and Business Research, Winter, pp. 47-51. 11. Pike, R. H. (1988, "An empirical study of the adoption of sophisticated capital budgeting practices and decision-making effectiveness", Accounting and Business Research, Autumn, pp. 341-51. 12. Pike, R.H. (1996, "A longitudinal study of capital budgeting practices", Journal of Business Finance and Accounting, Vol. 23 No. 1, pp. 79-92. 13. Porter, M. (1992, "Capital choices: changing the way America invests in industry", Journal of Applied Corporate Finance 5, pp. 4-16. 14. Primrose, P.L. (1991, Investment in Manufacturing Technology, Chapman Hall, London. 15. Scapens, R.W. and Sale, J.T. (1981, "Performance measurement and formal capital expenditure controls in divisionalised companies", Journal of Business Finance and Accounting, Vol. 8 No. 3, pp, 389-419. 16. Taggart, R.A. (1987, "Allocating capital among a firm 's divisions: hurdle rates vs budgets", Journal of Financial Research, Vol. 10, pp. 177-90.