Investment appraisal methods used in practiceInternational experiences
Survey research undertaken in the USA shows that the same broad usage of the
investment appraisal methods applies there as in the UK (Scapens, Sale and Tikkas
1982; Moore and Reichert 1983; Levy and Sarnat 1988; Chen 1995; Graham and Harvey
2001). In the past, there seemed to be a greater incidence of the use of discounting
methods than in the UK, but this difference no longer seems to exist. Interestingly, PBP
seems to be as popular in the USA as it is in the UK.
According to evidence cited by Bhimani, Horngren, Datar and Foster (2008),
methods used in investment appraisal differ markedly from country to country. In
most countries cited, PBP is very popular; NPV and IRR are fairly widely used. ARR
is not very popular anywhere (except, it seems, Japan – see below).
Hodder (1986) also found little usage of discounting techniques of investment
appraisal in Japan. He did, however, encounter widespread use of a net future
value assessment. As we discussed earlier in this chapter, this approach is a logical
alternative to NPV, and will give the same signals. Another widely used approach that
Hodder found to be used in Japan was a version of ARR that included an allowance
for interest on the investment finance in deducing the annual accounting profit.
Hodder noted an emphasis on ‘consensus’ decision making, where managers at
various levels discuss major investments at length, and where the results of formal
financial appraisal are only part of the process of reaching a decision.5.7 An example of an investment appraisal
There is evidence that many businesses, perhaps most of them, base their investment
decisions only partly on quantitative, financial assessments of each opportunity. Chen
(1995) surveyed 115 stock market listed, large US manufacturing businesses. He found
much the same popularity of the established financial appraisal methods as previous
US researchers. He also found heavy reliance on non-financial methods. Overall, the
discounting methods (NPV and IRR) were more popular than either PBP or ARR, but,
for all types of investment, non-financial methods ranked almost as highly as the
discounting methods, and well ahead of either PBP or ARR.
Alkaraan and Northcott (2006) found a similar state of affairs in the UK, with non-
financial issues being regarded as very important by investment decision makers.
Non-financial methods here included such matters as whether the particular
investment under consideration fitted in with the general strategy of the businesses,
whether it seemed to have growth potential and whether the competitive position of
the product and the business would be improved.
It can be argued that these so-called non-financial issues are simply financial ones
that are particularly difficult to quantify. For example, a business would be keen to
invest in a way that fitted in with its general strategy because it believes that this will
tend to lead it into areas that are likely, in the long run, to be those with the greatest
wealth enhancement potential.
The relationship between corporate strategy and investment appraisal is explored
in Chapter 5.