Chapter 5 • Practical aspects of investment appraisal
Objectives are much more precise and operational. We reviewed possible objectives
in Chapter 2 and concluded that, for most businesses, maximisation of wealth seems
to be a major objective, if perhaps not the only one. The essential feature of objectives
is that courses of action must be capable of being assessed against them. In other
words, identifying objectives is not helpful unless the business can distinguish be-
tween meeting them and failing to meet them.Undertake a position analysis
This step seeks to identify how the business is currently placed relative to its environ-
ment (competitors, markets, technology, the economy, political climate and so on), in
the context of the business’s mission and objectives. This is often formally approached
through an analysis of strengths, weaknesses, opportunities and threats (a SWOT
analysis). The first two of these are factors that are internal to the business. Strengths
might include such matters as technical expertise, strong finances and access to mar-
kets. Weaknesses are such things as lack of experience, lack of access to new finance
and lack of access to raw materials. Opportunities and threats are external factors.
Opportunities might include a new market opening, some new technology developing
or a competitor leaving the market. Threats could be factors such as a new competitor
entering the market, the decline of a market or a change in the law that will make it
harder for the business to operate.
It is not essential that the position analysisbe carried out in the SWOT framework,
though this seems to be a popular approach.Identify and assess the strategic options
This step is concerned with pursuing the business’s mission and objectives by trying
to identify courses of action that use the business’s strengths to exploit opportunities,
and at the same time avoid, as far as possible, the business’s weaknesses being ex-
posed to the external threats.
Note that however good the strategic ‘fit’ of making a particular investment, if that
investment does not have a positive NPV, it should not be undertaken. The UK
budget airline easyJet plcbought a small rival airline, GB Airways Ltd, in late 2007.
The Financial Timesclearly felt that easyJet had made an investment that fitted its
strategic objectives.easyJet agrees to shell out £103m to buy a rival UK airline, GB Airways... GB is a good
strategic fit for easyJet. It operates under a British Airways franchise from Gatwick,
which happens to be easyJet’s biggest base. The deal makes easyJet the single largest
passenger carrier at the UK airport. There is plenty of scope for scale economies in
purchasing and back office functions. Moreover, easyJet should be able to boost GB’s
profitability by switching the carrier to its low-cost business model...easyJet makes an
estimated £4 a passenger, against GB’s £1. Assuming easyJet can drag up GB to its own
levels of profitability, the company’s value to the low-cost carrier is roughly four times
its standalone worth. (Hughes 2007)Hughes makes the point that this looks like a good investment for easyJet, because
of the strategic fit. For a business other than easyJet, the lack of strategic fit might well
have meant that buying GB for exactly the same price of £103 million would not have
been a good investment.‘
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