The misapplication of capital investment appraisal techniques
Drury, Colin, Tayles, Mike. Management Decision. London: 1997. Vol. 35, Iss. 2; pg. 86
Abstract (Summary)
An examination of the surveys of capital budgeting practices that have been undertaken during the past 20 years in both the UK and US reveals a trend towards a continuing increase in the use of more sophisticated capital budgeting techniques. In a longitudinal survey of capital budgeting practices of large UK companies between 1975 and 1992, substantial increase in the usage of discounted cash flow (DCF) and risk appraisal techniques was reported. Despite the increased usage of the more theoretically sound discounting techniques, several writers in both the UK and US have claimed that companies are underinvesting because they misapply or misinterpret DCF techniques. It has been asserted by several writers that firms are guilty of rejecting worthwhile investments because of the improper treatment of inflation in the financial appraisal. Many firms are understating NPVs and IRRs because of the incorrect treatment of inflation and the use of excessively high discount rates. Concern has also been expressed by various commentators that many companies are failing to invest in advanced manufacturing technologies (AMT) as fully as they should. Financial appraisal techniques have been cited as a major reason for the under-investment in new manufacturing technology. DCF procedures should not be ignored or relegated in importance merely because they might be used incorrectly. Instead, decision-makers should recognize potential problems and be careful to ensure that the financial appraisal is performed correctly.
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