Special report: Investment appraisal

Investment appraisal is a key area in most businesses. Decisions concerning capital expenditure, coupled with strategic planning, marketing and organisational design are frequently critical in determining the future success of the business. This document advises managers on how they can contribute effectively to decision making and control during the process of investment appraisal.

Investment appraisal should not be confined to financial appraisal and must take place within the overall strategy of the business. Managers should equip themselves to participate and contribute to all stages of the process. The investment appraisal process includes the generation of ideas, assessment and authorisation, implementation and control of the project. No appraisal technique can guarantee success. All investments involve risk and judgement. A disciplined approach helps management to make rational decisions based on the probable impact of an investment on the future of the business.

The presentation of the proposed investment to the decision makers is as important as the process of gathering and evaluating information. The way such a presentation is made often determines the extent to which the appraisal influences the decision.

This special report is based on a ‘Guidance to Good Practice’ booklet issued by a predecessor of the faculty in 1986. Remarkably most of the original text remains relevant. The economic theory on which the mathematics are based is little changed and still forms the basis for accountancy examinations. We have added a brief section summarising current issues in investment appraisal (see page 26).

These issues are:

• DCF and sustainability;
• the risk that financial tools can be innovation killers;
• credit crunch and the recession;
• globalisation; and
• theory and practice.

When learning investment appraisal, much time and effort is spent on understanding the mathematics. When applied in business, the finances are the bedrock but the management factors become much more important. Managing people, making them accountable for their actions and putting practices in place which, although technically imperfect, allow effective management of the process in a complex organisation are crucial issues. It is about much more than the numbers.

The Finance and Management Faculty would like to thank the members of the faculty committee for their help in scoping, reviewing and providing content for this report. Special thanks go to Dr Ruth Bender (Cranfield School of Management), Martin Bennett (University of Gloucestershire Business School), Judith Shackleton (TelecityGroup), Simon Jones (BT), Kelly Smith (Investment Property Databank), Daniel Holden (Home Learning College), Helen Stevens (INSEAD Alumni Association UK) and Paul Chan (Maersk).

Published by the Finance and Management faculty (SR27 - December 2009)