Measuring Investment Appraisal Effectiveness – A Systematic Review
This study seeks to investigate the relationship between investment appraisal techniques used and effective investment decisions of listed manufacturing companies in Sri Lanka. Data collection was accomplished via questionnaire and interviews; questions focused on appraisal techniques, risk analysis techniques and firm size served as control variables in this questionnaire.
Cost-Benefit Analysis (CBA)
CBA (Cost Benefit Analysis) compares an anticipated project’s estimated or projected costs and benefits. As part of project management, this analysis can help you evaluate whether your venture is financially sustainable as well as detect any potential losses before they arise.
Both CEA and CBA utilize similar underlying frameworks; their main difference lies in how they view valuation of desirable consequences and implications associated with different methods of valuation. CEA places greater focus on cost per effect of interventions while CBA values all effects as monetary returns.
Critics of CBA point out its drawbacks by not taking non-monetary benefits into account and by disregarding uncertainty and discounting future values.
Cost-Benefit Ratio (CBR)
An effective investment appraisal process can improve your company’s financial condition by helping to allocate resources more efficiently, foster informed decision-making within your business and encourage innovation – not to mention shape its overall strategy and market presence.
To calculate CBR, you need an understanding of expected cash flows and related costs, as this will enable you to estimate when an initial investment will be recouped. There are a variety of techniques you can use such as discounted cash flow methods or sensitivity analysis which may assist with this calculation.
CBR of 1 or greater indicates that benefits exceed costs, making the project financially sustainable. A CBR less than 1 indicates it may still be worthwhile pursuing, provided it meets strategic objectives.
Internal Rate of Return (IRR)
Investment appraisal is an integral component of financial management, helping organizations make informed investment decisions and align capital investments with firm owner goals of wealth maximization for enhanced performance and improved efficiency. When evaluating potential projects it is also crucial to keep weighted average cost of capital in mind.
IRR is a commonly-used measure to assess investment profitability, yet should not be relied upon alone as it doesn’t give an estimate of actual annual return and it only offers estimates based on estimated values.
As well, IRR doesn’t take into account all of the risks involved with a project; to better assess them, sensitivity or scenario analyses would be more suitable approaches to risk analysis.
Discounted Payback Period (DPB)
The payback period is an increasingly popular investment appraisal technique that measures how long it will take an initial outlay to be recovered through cash inflows, providing businesses with a useful means of comparing competing projects. Unfortunately, however, this method doesn’t take account of time value of money which can lead to incorrect evaluation.
Effective investment appraisal processes can assist companies in making sound financial decisions that align with strategic goals. They also identify and assess risks that could harm an investment’s profitability, such as using weighted average cost of capital calculations to ensure projects meet or surpass this threshold and are adding value; this allows businesses to avoid costly errors that lead to subpar investments.
Sensitivity Analysis
Effective investment appraisal processes can significantly enhance a company’s financial performance by ensuring projects align with strategic objectives of the organization, risks are properly identified, evaluated, and mitigated, such as Amazon’s rigorous capital budgeting techniques that enable them to efficiently evaluate potential new initiatives that lead to their dominance in e-commerce market share.
These tools assist finance teams in prioritizing investment projects with high potential returns while effectively managing risk. Furthermore, these approaches can improve transparency by reducing the amount of information to be disclosed; however they do have certain restrictions as they may not capture all possible impacts associated with an investment project.
Sensitivity analysis is an approach used to gauge the robustness of an analysis by altering key variables within a model, which helps finance teams detect errors in the original analysis and rectify them quickly and efficiently.
