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4.6 Investment appraisal methods used in practice

Table 4.1Summary of the relative merits of the four investment appraisal techniques

NPV IRR PBP ARR

Directly related to the wealth Yes No No No

maximisation objective

Fully accounts for timing of cash Yes Yes No No

flows and the time value of money

Takes account of all relevant Yes Yes No Yes

information (other than timing)

Practical, easy to use and Yes Usually Yes Yes

provides clear signals

Table 4.2Investment appraisal methods used in practice in the UK

Date of survey: 19751 19811 19862 19923 19974 20025

%%%%%%

Net present value 32 39 68 74 97 99

Internal rate of return 44 57 75 81 84 89

Payback period 73 81 92 94 66 96

Accounting rate of return 51 49 56 50 55 60

Total 200 226 291 299 302 344

Sources: 1 Pike (1982); 2 Pike and Wolfe (1988); 3 Pike (1996); 4 Arnold and Hatzopoulos (2000); 5 Alkaraan and

Northcott (2006)

4.6 Investment appraisal methods used in practice

Having considered the attributes and the theoretical strengths and weaknesses of the

methods used in practice, it seems appropriate to consider the extent to which these

methods are actually used by businesses.

The past thirty years have seen a large volume of research into the methods of

investment appraisal used in practice. The more relevant of these for UK businesses

were conducted by Pike (1982, 1996), by Pike and Wolfe (1988) (P&W), by Arnold and

Hatzopoulos (2000) (A&H), and by Alkaraan and Northcott (2006) (A&N).

Pike and P&W concentrated on very large businesses, in fact 100 of the largest 300

UK businesses. A&H surveyed 100 of the largest 1,000 UK businesses. A&N surveyed

271 large manufacturing businesses. These survey results are broadly comparable and

provide an indication of how practices have changed over recent decades. The results

may be summarised as shown in Table 4.2.

These results suggest a number of factors that we shall consider next.

Appraisal methods and corporate objectives

An important point that we should bear in mind as we consider these research

findings is that the choice of investment appraisal methods can quite logically be seen

as evidence of the financial objectives that businesses are following. This is because,

when making investment decisions, businesses are frequently making judgements

that will have the most profound effect on their future welfare and success.