The misapplication of capital investment appraisal techniques

Colin Drury Professor, University of Huddersfield, Huddersfield, UK Mike Tayles Lecturer, University of Bradford, Bradford, UK
Surveys of capital budgeting practices in the UK and USA reveal a trend towards the increased use of more sophisticated investment appraisals requiring the application of discounted cash flow (DCF) techniques. Several writers, however, have claimed that companies are underinvesting because they misapply or misinterpret DCF techniques. Such claims have been made on the basis of observations in only a few companies, or anecdotal evidence, without any supporting statistical evidence. Reports on a recent survey conducted by the authors which suggests that many UK firms are guilty of misapplying DCF techniques. Also provides evidence relating to some issues that have not been thoroughly examined in previous studies, namely the impact of company size and the relative importance that firms attach to different investment appraisal techniques.
An examination of the surveys of capital budgeting practices that have been undertaken during the past 20 years in both the UK and USA 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 Pike (1996) reported a substantial increase in the usage of discounted cash flow (DCF) and risk appraisal techniques. In 1975 32 per cent and 44 per cent respectively used net present value and internal rate of return. The corresponding percentages in 1992 were 74 per cent and 81 per cent. Pike also reported that whereas in 1975 most firms adopted one of two investment appraisal techniques (typically payback and accounting rate of return), by 1992 the most common method was to use a combination of four different