Investment Appraisal

Investment appraisal appears to merge two of the most important issues in the world of business finance; planning and shareholder wealth. An interesting thing about investment appraisal is the reliance on figures that are at best speculative. Can there be any real value to a practise that relies on estimation and assumption? Can the reliance on these tools actually create risk?

Some techniques used, such as payback period and accounting rate of return may provide insight into if/when the project can be profitable. The assumptions however compromise the techniques in their simplistic nature; rarely will a business' cashflow be so constant as to make payback period a reliable tool. The same issue can be said regarding accounting rate of return, with the use of profitability being far too easy to manipulate.

Despite it's obvious flaws, the considerations that are made involving time value of money are of great use to anyone considering an investment. If a business could be deemed to be marginally successful based on the current value of money, the risk of inflation diminishing any potential profits is far too significant not to consider.

Net present value (NPV) is also to analyse which objectives will generate shareholder wealth through goal congruence. If the calculated NPV figure is positive, it is recommended that investment should be made. The calculation of NPV has been criticised as being too complicated. As much as this may be the case, the evidence of it's use over many decades suggests that the benefits that can be reaped from this tool is such that the complications are justified.

The big debate revolves around whether people can deem the estimates made in investment appraisal to be accurate enough to trust. Personally, I would suggest that estimations in their very definition should not be trusted as absolute fact. Of course the estimation is, in successful investments, based on a great deal of market research which adds far more value and reliability to this tool. Based on the amount of research, and the fact that the people making these appraisals for multinational companies are making obscene amounts of money, the world of investment appraisal is a tool that companies would be foolish not to use. As always, it's a case of 'fail to plan, plan to fail'.