Storey (1995,315) considers the importance of the mathematical techniques. “The weighting of the four in order of importance is a matter of judgement for management, but those projects with superior N. P. Vs and I. R. Rs will normally be chosen. The other two methods may sway the selection decision when competing projects appear to produce approximately the same time value results. ” While being the method of assessment relied upon most the N. P. V has got some shortcomings.
The N. P. V does not take into account the amount of capital required for an investment. For example a project that has an initial investment twice as much as a competing project can have the same if not an advantageous N. P. V, the size of initial investment can have a serious effect if the project fails in any way. Companies attempting to take into account risk by changing the rate used in the N. P. V calculations can also misuse the N. P. V method.
Frank Lefley and Malcolm Morgan have atempted to address this by developing a net present profile (NPVP) which also takes into account a payback period and growth rate. In theory this can help improve the system of investment appraisal although if you put the wrong data in to the calculations you will still get the wrong answer. It has also been noted for companies to decide upon which method of analysis to use in order to get the funds they require to carry out a specific project. It is conceivable that these methods are used to support Dewing’s 4 motives.
If every effort possible is not made to quantify any beneficial outcomes of a prospective project the proposal can become more subjective and dependent on management alone, rather than relying on the analysis of an accountant. To a large extent it varies as to what type of project is under assessment. A decision as to whether to introduce new products based on the product life cycle can be assessed almost entirely on financial maths once the product itself (to tie in with the company’s corporate image) has been chosen.
The relatively simple task of evaluating expected profits is the main consideration that will come into play. The same cannot be said however, when considering not-for-profit organisations, such as charities and government agencies. While they will consider potential savings involved in undertaking some form of capital expenditure it is often a non-financial benefit which is intangible that is the influencing factor. Kerr (1997) gives one possible scenario where this may occur “A commercial organisation may have a proposal to build a canteen at its factory for the benefit of its employees.
The canteen may charge for the meals, but there may also be benefits to the company in terms of better staff morale, lower staff turnover and less time lost due to staff having to leave the factory to obtain their meals. The canteen may not be viable on financial criteria, but the non-financial aspects may help to make the proposal acceptable. ” To a certain extent whether or not the capital expenditure decision (in the not for profit organisation) has arisen through internal reasons or i. e. cost cutting or external demand.
For example in the case of a local council it may have little choice as to whether or not to construct traffic calming measures if there has been a spate of accidents in recent times. Granted they may be able to assess proposals from contractors to carry out the work but funds will be used that could be utilised elsewhere. Often however such decisions in local councils must go through their own bureaucratic processes. It seems the finance sector’s quest for standards and protocol have made the process of investment appraisal decisions somewhat more standardised.
Decisions based on personal feelings and desires have become less common today. However many are still based on “what we want to do” rather than pure economic theory alone, the current incorporation of the two methods is probably the closest we will get to a pure method of analysis, as motives, desires and ideals are the true essence of entrepreneurial skill.
Bibliography: Management and Cost Accounting, Drury C, 1996, 4th edition, international Thomson press Cost and Management Accounting: 2, Coulthurst ; McAulay, 1991, Longman group, London
