Traditional Investment Evaluation Methods - Coursework Example

Introduction The market environment is continuously evolving and undergoing changes. This has increased the degree of competition and intensified pressure on manufacturing organizations as they have to find out a mechanism to deal with the changing environment. The increasing demand for being innovative, being flexible and developing new and better appraisal techniques through which industry structure maximizes have to be found out (Carter, 1992). This has increased the need and importance of developing new and better appraisal techniques so that they are able to deconstruct, analyze and then reconstruct the different dimensions through which value factors will be determined. This essay looks at evaluating the manner in which traditional investment appraisal techniques are being unable to cope with the changing market conditions and the different ramification and changes which are required to be able to deal with the different business changes. This paper will further evaluate the manner in which different appraisal techniques have to be modified and converted towards better modern techniques so that maximum effectiveness and gains can be achieved. Traditional Investment Evaluation Methods Research has identified the fact that organizations to conduct a feasibility study on identifying the different investments that can be made in different companies use the financial const benefit analysis through the traditional capital investment appraisal techniques (CIAT). Some of the most commonly used traditional appraisal techniques are payback period, accounting rate of return, return on investment, internal rate of return, and new present value. This can further be seen from the chart below which shows the manner in which traditional investment techniques is being used frequently (Alkaraan and Northcott, 2006) The use of different traditional investment techniques had provided advantage to business as it had helped to identify the different areas where investment have to be made and also showed the manner in which business would benefit from the use of different capital investment appraisal techniques (Boston, 2002). The changing and evolving business environment has stressed the need and importance to develop the traditional method of appraisal so that better understanding of the business environment provides an opportunity through which better decisions can be taken. Mistakes with traditional appraisal approach Traditional method of capital investment appraisal method like payback period, accounting rate of return, return on investment, internal rate of return, and new present value have been criticized based on different factors. Some of the criticisms which have been raised against traditional investment methods and require the development of better methods are as Firstly, the investments appraisal techniques used in traditional times focuses on the narrow aspect of decision making. The techniques only look at the benefits which the department is able to get because of the different techniques but doesn’t look into the other benefits which other section of the society is able to get (Jonsson, 2000). For example an investment made in the computer programming software not only benefits the concerned department but also helps the production department to understand the production pattern which thereby ensures that necessary arrangement for the resources can be made. This is an aspect which is ignored in the traditional investment appraisal approach which needs to be fixed for better decision making understanding the manner in which business decisions will benefit them. Secondly, the traditional investment appraisal techniques don’t consider the non financial benefits which the business is able to derive because of the different investment decisions which are taken. In fact manufacturing units not only account for the financial gains of the business but also focuses on the non financial aspect as understanding the different benefits that business acquire through it (Adler, 2000). This aspect is especially witnessed in case of terminal projects where only the financial gains for the business is accounted which the business is able to gain during the period but doesn’t consider the non financial benefits which will accrue after the termination of the project. This aspect has an impact on decisions taken by the manufacturing units and could lead towards creation of a situation where the business is able to gain so that maximum productivity and better decisions can be achieved (Dean & Snell, 1991). Thirdly, the traditional investment appraisal technique focuses on the short term and doesn’t consider the longer term. It is seen that manufacturing concerns takes a lot of time to become fully operational and ensures that it works at full capacity. Sometimes it might take years to achieve it which is not considered in the traditional investment appraisal techniques (Boyer, Ward & Leong, 1996). The non discounted cash flow method especially highlights these problems which might at times even face the feasible projects looks infeasible. This thereby impacts the investment decisions and makes it difficult for the business to achieve efficiency in decision making. It can also be looked from another perspective which states that some manufacturing investment proposal might be feasible but since the long term focus is ignored it might make the project look infeasible. This would thereby impact the decision making and would have an impact on the business decision making (Small & Yasin, 2003). Fourthly, the assumptions which have been considered under the traditional investment appraisal method are far from reality. It is assumed that the current competitive position won’t be affected if the investment is not made (Chan, Chan, Lau, 2001). This could be untrue because other organizations might look towards some degree of innovation, changes and modification which would thereby change the entire competitive nature of the business. An unwillingness to invest presently and looking to invest in the future considers the same risk for the business. This is hardly a reality as the continuous changes in the dynamic environment have resulted in widespread changes in the overall style of decision making. This is an aspect which needs to be considered while looking to take decisions so that the different assumptions which are considered is true and helps to find out the fundamentals based on which effective and correct business decisions will be made. Fifthly, the traditional investment appraisal techniques often provide an inconsistent approach to inflation which thereby also results in inconsistent treatment being provided to inflation. Inflation is an important factor which has to be considered by the manufacturing concerns so that business is able to identify whether to produce at a certain cost will be beneficial or not (Pointon, 2002). This is ignored by the traditional capital investment appraisal techniques as it doesn’t consider those changes. This thereby doesn’t help to provide correct directives based on which manufacturing concerns will be able to take correct decisions. The modern appraisal techniques needs to consider and identify the different factors which will help to make better and informed decisions so that business effectiveness is gained. Sixthly, the hurdle rate which is used to find out whether the investment is appropriate or not is not clear as the investment appraisal techniques used in traditional times doesn’t consider the seriousness of hurdle rate. The lack of efficiency and effectiveness to find out the correct hurdle rates at time leads towards choosing the incorrect projects and rejecting the correct projects (Burcher & Lee, 2000). This thereby has an impact on the long term decision making and impact the overall mechanism through which business decisions are made. The newly developed appraisal techniques considers the different hurdle rate and based on aims towards finding out a mechanism through which correct business decision is made. Adjusted Traditional Investment Appraisal Method The manner in which different deficiencies and criticism has been raised against traditional investment appraisal techniques have highlighted the need and importance of filling those deficiencies so that better and informed business decisions are made. To deal with the changing business environment it has become imperative that the following two mechanisms are used Firstly, the mechanism was made where adjustments were made to the traditional investment appraisal techniques so that the gaps which are identified can be filled. The mechanism of adjusting the traditional investment appraisal techniques has helped to ensure that the techniques are well suited and developed to meet the changing business needs and it ensures that the techniques which are used are already tested and proven so that the chances of errors and understanding can be reduced (Lefley, 2000). This has thereby forced the traditional appraisal method to undergo the required changes based on the changing business needs and demands so that better strategies can be developed through which better decisions are taken. Secondly, is the development of completely different and new techniques which is different from the traditional investment appraisal techniques and focuses on working and filling the different gaps which were highlighted in the traditional methods? This has helped to formulate strategies based on the needs and requirements of the changing business environment and has helped to develop an opportunity through which the degree of competition can be reduced and the business is able to increase effectiveness in the use of resources (Arnold and Hatzopoulos, 2000). Manner in which new techniques will help The development and adjustments being made to the traditional investment appraisal techniques like payback period, accounting rate of return, return on investment, internal rate of return, and new present value will help to understand the changing business needs. This will thereby help to focus on areas through which the business will be able to find out the different needs and requirements so that adjustments can be made to hurdle rate, inflation, changing business environment and so on (Kalpan, 1986). This will thereby help to improve the focus and ensure better concentration on areas through which better decisions are taken. The overall phenomenon will focus on working on the different directives through which competitive nature of the business environment is better studied and based on it a framework is developed through which the business is able to take better and informed decisions. The use of different traditional investment techniques had provided advantage to business as it had helped to identify the different areas where investment have to be made and also showed the manner in which business would benefit from the use of different capital investment appraisal techniques (Adler, 2000). The changing and evolving business environment has stressed the need and importance to develop the traditional method of appraisal so that better understanding of the business environment provides an opportunity through which better decisions can be taken. Conclusion The paper thereby shows the manner in which traditional investment appraisal techniques helped the business in different ways. It highlights the different gaps and areas which needs to be considered while looking to deal with the competitive business environment. The changing business environment has made it mandatory that the different gaps which the traditional investment appraisal techniques shows are filled and better and new techniques through which correct evaluation takes place is developed. This will help to improve the overall focus and will provide a framework through which better and informed decisions which will help the business will be taken. References Adler, R.W. (2000), Strategic Investment Decision Appraisal Techniques: The Old and The New, Business Horizons, November/December, Pgs 15-22, (Expanded Academic ASAP International) Arnold, G. C. and Hatzopoulos, P. D. (2000), The Theory-Practice Gap in Capital Budgeting: Evidence from the United Kingdom. Journal of Business Finance and Accounting (June) Vol 27, Issue 5-6, Pgs 603 - 626 Alkaraan, F. and Northcott, D. (2006) Strategic capital investment decision-making: A role for emergent analysis tools? A study of practice in large UK manufacturing companies. British Accounting Review, Vol 38 Issue 2, Pgs 149-173 Boston, J. (2002), Purer Speculation, Financial Management, March, Pgs 34-35 Carter, W K (1992), To invest in new technology or not? New tools for making the decision. Journal of Accountancy (May) Pgs. 58-64. 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(2000), An Empirical Taxonomy of Advanced Manufacturing Technology, International Journal of Operations & Production Management, Vol 20, No 12, pgs 1446-1474 Small, M. & Yasin, M. (2003), Advanced Manufacturing Technology Adoption and Performance: The Role of Management Information Systems Departments, Integrated Manufacturing Systems, Vol 14, No 5, pgs 409-422 Read More