4.1 Introduction
Businesses operate by raising finance from various sources, which is then invested in
assets, usually ‘real’ assets such as plant and machinery. Some businesses also invest
in ‘financial’ assets, like the shares of another business or loans to businesses and indi-
viduals. Investment involves outflows (payments) of cash causing inflows (receipts) of
cash. It is in the nature of things that cash flows (out and in) do not all occur at the
same time: there is some time lag, perhaps a considerable one, between them. The
typical investment project opportunity involves a relatively large outflow of cash
initially, giving rise to a subsequent stream of cash inflows.
The business’s balance sheet gives, at any particular point in time and subject to the
limitations of such financial statements, the types of investment that it still has run-
ning. Balance sheets group assets by type (non-current assets, current assets and so on)
rather than by investment project. Thus it is not possible from the standard balance
sheet to discern which part of the non-current and current assets relate to any particu-
lar project. Nonetheless, a glance at a business’s balance sheet would give us some
idea of the scale of investment and to some extent an idea of its nature.
Selecting which investment opportunities to pursue and which to avoid is a vital
matter to businesses because:
Investment appraisal methods
In this chapter we shall deal with the following:
‘the importance of the investment decision
‘the derivation of the concept of net present value
‘an explanation of the meaning of net present value
‘a consideration of the other approaches used to assess investment projects
‘a consideration of some recent research bearing on the investment appraisal
techniques used by businesses in the UK and elsewhere in the world
Chapter 4