Chapter 5 • Practical aspects of investment appraisal
The extent of the use of post audits had increased from 33 per cent in 1975 to 46 per
cent in 1980, to 64 per cent in 1986, and to 72 per cent by 1992. This had risen to 95 per
cent by 1997 according to Arnold and Hatzopoulos (2000) who surveyed a similar
group of businesses to Pike. Clearly, the use of post audit has expanded strongly over
the years.
Given these research findings it would be expected that major businesses would
have fairly sophisticated routines surrounding all aspects of investment decisions.
Many businesses comment on what they do.
The engine and power systems manufacturer Rolls-Royce plcseems to be a
business that follows a policy of reassessing existing investment projects. It said in its
2006 annual report: ‘The group has a portfolio of projects at different stages of their life
cycles. Discounted cash flow analysis of the remaining life of projects is performed on
a regular basis.’ Presumably, any projects that have a negative NPV are abandoned.
Reckitt Benckiser plc, the manufacturer of household goods such as Dettol and
Harpic, in its 2006 annual report says: ‘there is a structured process for the appraisal
and authorisation of all material capital projects’.
The regional brewer and pub owner Greene King plcsaid in its 2007 annual report:
‘There are clearly defined evaluation and approval processes for acquisitions and
disposals, capital expenditure and project control. These include escalating levels
of authority, detailed appraisal and review procedures and post completion reviews
of all major projects to compare the actual with the original plan.’
The betting and gaming business Ladbrokes plcsaid in its 2006 annual report:
‘There was a group-wide policy governing appraisal and approval of investment
expenditure and asset disposal. Major projects were reported on at each regular Board
meeting. Post investment audits were undertaken on a systematic basis and were
formally reviewed by the Board twice yearly.’
In practice, the accuracy of estimating the inputs for the decision seems question-
able. The management consultants McKinsey and Co. surveyed 2,500 senior managers
worldwide during the spring of 2007 (McKinsey 2007). The managers were asked their
opinions on investments made by their businesses in the previous three years. The
general opinion was that estimates for the investment decision inputs had been too
optimistic. For example sales levels had been overestimated in about 50 per cent of
cases, but underestimated in less than 20 per cent of cases. It is not clear whether the
estimates were sufficiently inaccurate to call into question the decisions that had been
made. The survey went on to ask about the extent that investments made seemed, in
the light of the actual outcomes, to have been mistakes. Managers felt that 19 per cent
of investments that had been made should not have gone ahead. On the other hand,
they felt that 31 per cent of rejected projects should have been taken up. Managers also
felt that ‘good money was thrown after bad’ in that existing investments that were not
performing well were continuing to be supported in a significant number of cases. It
seems that not all businesses carry out the kind of analysis undertaken by Rolls-Royce
(see above) or, if they do, they do not do it properly.
Some criticism has been made of researchers in capital investment appraisal
implying that they have tended to concentrate on the minutiae of the quantitative
assessment of projects, leaving largely untouched questions surrounding the search
for possible projects.
The quantitative appraisal is a purely technical process, even though a complicated
one at times. The real test of managers’ talent is whether they can identify good pro-
jects that will promote the achievement of the business’s objectives. Reliable appraisal
is vital, but it is a low-level task by comparison.