The Investment Appraisal Techniques Accounting Essay

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According to survey by Pike it shows that majority used payback method with an increase of 8 in 5 years. There is also an increase of 12 of internal rate of return (IRR) which in theory is more superior to accounting rate of return (ARR).

The majority of the companies favoured the traditional method at the time, this might be because it is easy to use and also most businesses might have been interested in short term returns and as these techniques do not take into consideration the time value of money they would be suitable for assessing this type of projects.

Over time the techniques used have changed, with the changes in information technology, there are different types of software available making it easy to perform tasks that deemed cumbersome in 1980's. Drury et al (1993) agrees by stating that companies are using more sophisticated techniques, and some companies are even using multiple techniques to assess their capital investment projects. Table 4 of Arnold and Hatzopoulos (2000 p.606) shows that the use of four appraisal methods is popular with majority of the larger companies this could be because these companies have the means to perform the different techniques.

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Drury et al (1993) Alan Sangster (1993) and Mills and Herbert (1987), suggests that the size of the company will determine the technique used, below is a survey by Drury et al (1993) comparing the size of the company and appraisal techniques.

All

Smaller

Larger

No=278

No=43

No=46

%

%

%

Payback (adjusted)

63

56

55

Discounted payback

42

30

48

Accounting ROCE

41

35

53

Internal rate of return

57

30

85

Net present value

43

23

80

According to the survey it shows that 85% of larger companies prefer using IRR while 80% are using Net present value (NPV), this agrees with Drury et al (1993) and disagrees with the results by Pike (1983) although there is still high percentage of companies using payback which are smaller companies but this could be because they have a different organisational structure and lack of financial abilities to perform NPV and IRR which are more costly and time consuming. The usage of these techniques depending on the size of company has been further broken down into how this companies use this techniques by Arnold and Hatzopoulos resulting with the following table

Frequency of Use of Financial Analysis Technique

Rarely

Often

Mostly

Always

%

%

%

%

Small Firms

Payback

15

12

15

35

ARR

6

18

15

29

IRR

6

9

18

44

NPV

9

18

18

26

Medium Firms

Payback

8

25

8

32

ARR

8

29

13

13

IRR

8

25

13

42

NPV

13

21

8

42

Large Firms

Payback

18

16

24

24

ARR

8

11

16

32

IRR

3

3

26

55

NPV

3

5

29

58

The results of the usage according to the survey done by Arnold and Hatzopoulos (2000) agree with sangster's survey results, that NPV and IRR as the most used by large and medium sized companies when small companies are using IRR and payback mostly. It is fair to say that there's a few percentage of companies who rarely make use of these techniques, with 13% of the medium sized companies rarely using the NPV probably because most of the managers have not fully understood the technique and therefore opt to not use it.

Conclusion

I can also conclude that no matter the changes in environment or improvement of information technology payback method will still be a popular technique used by companies this is evident from survey done by Pike (1983) Drury (1993) Arnold and Hatzopoulos (2000). Even though some of the techniques grew in popularity as they provided more clear decision making results, payback is still being used at a higher rate, while ARR has decreased

The use of these investments requires an understanding of the techniques, it is understandable that some projects it is hard to get the value of inflows and outflows and therefore avoid the use NVP. But companies that do not use this technique because they do not understand it should understand that taking time value of money into consideration helps to avoid investing in a risky project.

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I do not agree that most companies don't make use of investment appraisal techniques, but I do believe that most of the managers need to be informed about the advantages and disadvantages of using these techniques, just because payback is easily understood does not make it a good appraisal technique but it can be made better when used with other techniques as has been suggested. Drury et al (1993) cited by Watson and head (2010)