Title ± page I


Dissertation submitted in part of the requirement for the degree of Master of Business Administration at Liverpool John Moores University




Declaration ± page II


I declare that no portion of the work referred to in the dissertation has been submitted in support of an application for another degree or qualification of this or any other university or other institute of learning. Further, all the work in this dissertation is entirely my own, unless referenced in the text as a specific source and included in the bibliography.

Acknowledgement ± page III

ACKNOWLEDGEMENT All Praise for Allah Subanahu-wa-Tala whose guidance and full help in the form of kind people around me for assistance. This paper of academic research is not only an outcome of my strenuous and unbearable mental and physical stress. It is also a sponsorship of my most close dissertation supervisor Dr. Mike Doyle. His straight and best advice and critic review of my work made me achieve this most difficult project. He worked so close with me and provide all kind of support within fair means. His emailed advises was priceless support and guidance to my research dissertation. Apart from Dr. Mike I would like to mention Kaplan Professional which provides a great opportunity for me to finish my MBA dissertation with such a broad topic. The resource room facility for workshops seminar and turnitin report helps me keep the ownership of my dissertation. I am very obliged to British Library and all of its staff there especially inside the reading room at helps desk, as reference specialist, and co-coordinators of work shop such as researching companies. In my final words of ack nowledgement I would like to thank a very close friend mine Mr. Noman Ahmad Khan for his untiring support.

Contents ± page IV


CHAPTER 1 ................................ ................................ ................................ ..... 1 1 1.1 1.2 1.3 1.4 INTRODUCTION................................ ................................ ............ 1 TOPIC AND ISSUE OVERVIEW ................................ ..................... 1 BACKGROUND OF THE STUDY ................................ ................... 2 DISSERTATION QUESTION ................................ ........................... 3 DISSERTATION AND OBJECTIVES ................................ .............. 3

CHAPTER 2 ................................ ................................ ................................ ..... 4 2 2.1 2.1.2 2.2 2.2.2 2.2.3 METHODOLOGY................................ ................................ ........... 4 RESEARCH PHILOSOPHY ................................ ............................. 4 Ethical Justification of Research Philosophy ................................ ...... 5 RESEARCH METHODOLOGY ................................ ....................... 6 Research Data Collection ................................ ................................ ... 6 Sampling Method ................................ ................................ ............... 8

CHAPTER 3 ................................ ................................ ................................ ..... 9 3 3.1 3.1.1 1) 2) 3) 4) 4a. 4b. 5) LITERATURE REVIEW ................................ ................................ 9 THEORIES, MODELS, and APPLICATIONS OF CIA ................... 10 THE THEORIES OF CIA ................................ ................................ 10 The Payback Period (PP)................................ ................................ .. 10 Accounting Rate of Return (ARR) ................................ ................... 11 Weighted Average Cost of Capital (WACC) ................................ .... 13 Discounted Cash Flow (DCF) ................................ .......................... 14 Net Present Value (NPV) ................................ ................................ . 15 Internal Rate of Return (IRR - Yield) ................................ ............... 16 Benefit & Cost Analysis (BCA) and Profitability Index (PI)............. 18

Contents ± page V

3.1.2 1) 1a.

THE MODELS OF CIA ................................ ................................ ... 19 Models On Cost Of Capital ................................ .............................. 19 JP Morgan Models on Cost of Default & Black-Scholes Option Pricing Model ................................ ................................ .................. 20

1b. 2) 2a. 2b. 2c. 2d. 3.1.3 1) 3.2 3.2.1 1) 2) 3) 4) 5) 3.2.2 1) 2) 3) 4) 5)

Economic Value Added Model ................................ ........................ 20 Other Models ................................ ................................ ................... 21 Modigliani and Miller (MM) Model ................................ ................. 21 Capital Asset Pricing Model (CAPM) ................................ .............. 22 Advance Manufacturing Technology (AMT) Model......................... 22 Models of Rationality ................................ ................................ ....... 22 THE APPLICATION OF CIA ................................ ......................... 23 CIA Application Flexibility for Decision Making ............................. 24 PERFORMANCE OF CIA APPLICATIONS IN ENGLAND .......... 26 THE DISCREPANCIES OF CIA ................................ ..................... 27 Implication of Inflationary Error ................................ ...................... 28 Investment Forecasting Error ................................ ........................... 28 Rate of Discount Error ................................ ................................ ..... 29 Implication of Taxations ................................ ................................ .. 29 Investment Time Horizon ................................ ................................ . 30 THE UNCERTAINTIES OF CIA ................................ .................... 31 Woking Capital ................................ ................................ ................ 31 Rate of Interest ................................ ................................ ................. 32 Gearing and Leverage ................................ ................................ ...... 32 Rate of Inflation ................................ ................................ ............... 33 Value at Risk (VaR) ................................ ................................ ......... 34

Contents ± page VI


Company Merger, Acquisition, and Joint VentureError!


not defined. 7) 3.2.3 1) 2) 3) 4) 5) 3.3 Decision Uncertainty................................ ................................ ........ 36 THE INCONSISTENCIES OF CIA ................................ ................. 37 Payback Period (PP)................................ ................................ ......... 37 Accounting Rate of Return (ARR) ................................ ................... 38 Weighted Average Cost of Capital (WACC) ................................ .... 39 Discounted Cash Flows (DCF) ................................ ......................... 40 Benefit & Cost Analysis (BCA) and Profitability Index (PI)............. 42 CONCLUSION OF LITERATURE REVIEW ................................ . 43

CHAPTER 4 ................................ ................................ ................................ ... 45 4 4.1 4.1.1 4.1.2 4.2 4.2.1 DISCUSSION AND RECOMMENDATIONS ............................. 45 DISCUSSION AND CONCLUSION ................................ ............... 45 Analytical Findings ................................ ................................ .......... 46 Misapplication and Mismanagement (M&M) ................................ ... 48 RECOMMENDATIONS ................................ ................................ . 54 Suggestions ................................ ................................ ...................... 58

SECTION 5 ................................ ................................ ................................ .... 59 5 5.1 5.2 5.3 REFLECTION ON LEARNING................................ ................... 59 IDENTIFICATION OF SELF REFLECTIVE LEARNING ............. 59 AWARENESS OF SELF REFLECTIVE LEARNING .................... 60 ANALYSIS OF SELF REFLECTIVE LEARNING ......................... 61

APPENDICES ................................ ................................ ................................ . 63 Chapter 2 - METHODOLOGY ................................ ................................ .......... 63 APPENDIX A ................................ ................................ ................................ .. 63 1. Research Resources................................ ................................ .......... 63

Contents ± page VII

Chapter 3 - LITERATURE REVIEW ................................ ................................ 63 APPENDIX B ................................ ................................ ................................ ... 63 APPENDIX C ................................ ................................ ................................ .. 63 1 2 3 Present Value Table ................................ ................................ ......... 63 Annuity & Present Annuity Table ................................ .................... 64 Perpetuities ................................ ................................ ...................... 64

APPENDIX D ................................ ................................ ................................ .. 65 1. 2. Probabilistic Treatment of Uncertainty ................................ ............. 65 Simulation Process for Uncertainty: ................................ ................. 65

BIBLIOGRAPHY................................ ................................ ............................ 66

Table and Figure List ± page VIII


1. 2. 3. 4. 5. 6. 7. 8. 9.

TABLE 1: Illustration of Payback Method................................................ 11 TABLE 2: Illustration of Accounting Rate of Return (ARR).................... 12 TABLE 3: Illustration of Weighted Average Cost of Capital (WACC)« 13 TABLE 4: Illustration of Net Present Value........................................«.. 15 TABLE 5: Net Present Value at Lower Discount Rate (NPVa)................ 17 TABLE 6: Net Present Value at Higher Discount Rate (NPVb)......««. 17 FIGURE 1: Application of Capital Investment Appraisal (CIA)........«.. 26 FIGURE 2: Kolb. D.A. (1984) Model of Experiential Learning Cycle« 59 TABLE 7: Abbreviations List in CIA....................................................... 63

10. TABLE 8: Illustration of Annuities.................................«......... .......«. 64

Formula List ± page IX


1. 2. 3. 4. 5. 6. 7. 8. 9.

Formula 1: Average Investment................................................................ 12 Formula 2: Accounting Rate of Return (ARR)......................................... 12 Formula 3: Accounting Rate of Return (ARR)......................................... 12 Formula 4: weighted Average Cost of Capital (WACC).......................... 13 Formula 5: Future value (FV)................................................................... 14 Formula 6: Present value (PV).................................................................. 14 Formula 7: Internal Rate of Return (IRR).................................«............ 16 Formula 8: Linear Interpolation................................................................ 17 Formula 9: Profitability Index.............................................................«.. 18

10. Formula 10: Fisher Equation for Rates of Inflation............................«.. 34 11. Formula 11: Value at Risk (Beta) ....................................................«.... 35 12. Formula 12: Present Value Annuity Factor........................................«.. 64 13. Formula 13: Present Value of Perpetuity......................................«........ 65

Dissertation ± Chapter 1 INTRODUCTION


The research topic is about the capital investment appraisal (CIA). The application of CIA is under research for the misapplication and mismanagement. The application has implications by different available financial options which have a vital importance and motivation for selecting CIA as research topic. However this is neither a topic of financial investment nor project appraisal. The narrowness of the topic is as much as it is carefully deals with the financial aspects of CIA. It focuses the research question and objectives only for the large size private enterprises in England. The overview of the issues is provided for selected topic for the dissertation on CIA. 1.1 TOPIC AND ISSUE OVERVIEW: An investment appraisal is a practical

financial document which can be prepare and applied by qualified consultants of management accountants. There are very few entrepreneurs who are completely aware to the CIA techniques. The CIA process and techniques are best suitable in England¶s private large enterprises for examine and ascertain what level of investment is required. Dixon (1994) the experience of investment instances suggests that the applications of CIA techniques are not completely and practically adaptable by large size investors in England for investment planning and decision making standards. The large businesses have better reasons to invest than any small and medium enterprises (SME). These institutions accept the importance of CIA technique for decision making in a project for the use of household or outsourced funds. The issue overview examines the area of complication where research would find results. These problematic areas are primarily the ³MISAPPLICATION and MISMANAGEMENT of Capital Investment Appraisal.´ This research project is aimed for analy tical finding in theories, models, and application, those causes practical misapplication and mismanagement by inconsistent and dysfunctional application of CIA techniques. Researcher should referenced Busby and Pitts (1998) to support his research question that there is not enough awareness of academic research among decision


Dissertation ± Chapter 1 INTRODUCTION

makers in CIA. Some of those aware managers unfortunately could not get access to such research academics. Beside this unawareness Gardner (1998) blames managing director of the investment companies for dysfunction decision making. It means an investment decision was in directors¶ favour instead it should be in company¶s favour. The researcher¶s objective to study is that the CIA technique must be acceptable without any misapplication and mismanagement. Importance of any related corporate issue would have its own unique significance for discussion in literature review. The research is not driven on the basis of facts that already available instead researcher has to analyse what are real key elementary factor affecting CIA to be true deliver for investment prospects. The background of the study is explained for its critical importance to selected topic in dissertation. 1.2 BACKGROUND OF THE STUDY: The rational of study is based on

misapplication and mismanagement of CIA in decision making for organizations that use these financial technique with available financial options. A CIA is a forecast report of future return on presently available capital in the form of financial resources. Upon CIA¶s satisfactory report the financial institutions approve financial resource for capital investment projects. Investment bank and financial companies in England have very strict term for allowing their finance to be outsourced for capital investment appraised projects. It is also the study of financial options drawback of CIA. The rationale behind research question is to point out the particular problems and issue that the CIA process is facing due to misapplications and mismanagement of financial options. CIA should be applied in the benefit of the investor to bail out externally and internally financial resourced projects. The researcher would discard any alternative rational for the sanctity of documentary reporting by unbias CIA. The entities would be use by case studies for gaining suggestion for large private businesses those seeking finance for their promising projects. ³Case studies also allow generalizations as that result of findings using multiple cases can lead to some form of replication.´ (Noor 2008:1602) fair investment proposal by help of CIA may not always be attractive for investment by private investor in England who wants rapid return. But it would motivate the prudential and well wishers of financially viable


Dissertation ± Chapter 1 INTRODUCTION

projects. There are enough number of significant financial implicating factors that are affecting the performance of CIA in private industry of England. ³Several writers, however, have claimed that companies are under investing because they misapply or misinterpret DCF techniques.´ (Drury and Tayles 1997: P86) recommendations and conclusive suggestions are required after fair treatmen to the research question by examine all implicating factors of misapplication and mismanagement. The suggestions will improve the management decision making of private investors in England. These would follow after the analytical discussion of finding by the researcher for his research question and bold objectives.



What are the possible implications of financial options in capital investment appraisal (CIA) misapplication and mismanagement for private sector businesses in England?



1. To analyse different theories, models, and applications of capital investment appraisals (CIA) of private sector for businesses in England. 2. To critically evaluate the complex performance of capital investment appraisals (CIA) in large scale private sector enterprises in England. 3. To elicits views and perspectives of investment institutions about capital investment appraisal (CIA) for England industry to expose possible discrepancies, uncertainties, and inconsistencies. 4. To recommend suggestions how to capital investment appraisals (CIA) may be improve to meet the aims of a more adaptable and applicable financial decision making process for private investors sector in England.

The researcher has to establish the links to the literature through critical review for research objectives. The methodology should be defined clearly so the reader would have better understanding of research process. The narrative structure of methodology is required to what has already been done in literature review for selective topic.


Dissertation ± Chapter 2 METHODOLOGY


The format guideline given in dissertation for the chapter of methodology has laid out two basic sections for research that is the research philosophy and research methodology. The research philosophy of post positivism is the stand point of researcher for the CIA. The research methodology is unique in this project because a desk work of theoretical research went in to the areas of theories, models, application of financial options by examining discrepancies,

uncertainties, and inconsistencies. ³Am I going to be genuinely interested in the topic? A real interest in a subject is virtually important.´ (White 2002:11) the research methodology could be justified by well extended in-depth, detailed, and comprehensive literature review consisting from all available sources. The entire research comes under research philosophy of post positivism. The researcher will explain his rational to research philosophy for selecting post positivist stance and rejecting any other alternative. 2.1 RESEARCH PHILOSOPHY: The chosen research philosophy is post

positivism because it is about the awareness and knowledge of CIA technique. The study has the significant reasons of misapplication and mismanagement based on the falsified theories and models. The researcher¶s post positivist philosophy is the best adopted philosophy for study. The researcher also finds post positivist philosophy suitable for the research to examine the latest findings by successors. That is also evident here that, Thus, there is never enough research to permit you to eliminate all doubt about your theory. On the other hand, if one study produces data that contradict your theory, that is enough to falsify the theory. You then look for a better theory, or modify your current theory, in response to the falsification. (Foundations Of Qualitative Research 2007:73) The study can be updated by modification and alteration in theories and models which are already based on falsification. The researcher reason is well justified and fit with the nature of research which has a history of modification that would be read by readers in the most important next chapter of literature review.


Dissertation ± Chapter 2 METHODOLOGY

The motivated topic of ³Capital Investment Appraisal´ had came from researcher¶s academic background.³Many part time students in business and management derive topics from their work experience.´ (Gill and Johnson 1997:12) this is an academic study but it could as well be an outcome from researcher¶s practical experience that he want to applied for researching the topic for private entities in England. Recently studied ³Managing Financial Principal and Techniques´ in management diploma which persuade him to select the broad topic of investment appraisal which should be segregated for CIA. The study was diversified and indeed complex joined with mathematical and technical issues of financial options. The researcher¶s basic knowledge of CIA theory would not be deferred although it would be alter for researcher post positivist stance. ³The difference is that the post-positivist critical realist recognizes that all observation is fallible and has error and that all theory is revisable.´ (Trochim 2006) Post Positivist rejects the idea of interpretive approach that collected data may not be of relevance and significance in comparison to modern research out come. Now it is more specialise field of study for post positivism research which could achieve project aim and objective by qualitative kind of literature review. The researcher associated his research philosophy of post positivist ethically with the case studies in the organizations which is knowledge and information area of financial business affairs.

2.1.2 Ethical Justification of Research Philosophy: The post positivist research methodology is the research philosophy plan layout. Issues deals in ethical philosophies which commonly known as axiology used by other researchers for their main philosophical approach. They have used post positivist or any other research philosophy such as interprevitism or positivism for their academic work. ³Ontology with realist foundations provides a basis for progress in the accommodation of knowledge in the post-positivist tradition.´ (Lobato 2010) similarly to other researchers the researcher also had compelling appeal and guideline to stick with desk base work of academic research. The financial sector was observed to find out how it can work with other organizations in favour of CIA. ³The general ethical issue here is that the research design should not subject


Dissertation ± Chapter 2 METHODOLOGY

those you are researching (the research population) to embarrassment or any other material disadvantage.´ (Saunders et al 2007:153) the ethical objective for seeking information from literature review of these organizations is to achieve the research question and objectives. It was relevant to gathered literature data for a critical review of argued question and to achieve its set objectives.


RESEARCH METHODOLOGY: In the entire study of CIA technique

researcher not only consulted the books from different writers who had explained the process in all it parts such as a tutorial guidance in CIA work books edited by DC Gardner. Researcher himself reviewed and understands theories, models, and applications. The entire process and techniques thoroughly consulted from previous academic learning in Advance Professional Diploma in Management. The researcher avoided the primary research due to limitation and probable denial of access in entities where CIA need to be discuss for it discrepancies, uncertainties and inconsistencies. The recommended and adopted as well as justified research methodology for academic study is the extended and comprehensive literature review.

2.2.2 Research Data Collection: The written literatures are available such as books and case studies in library, news paper¶s articles, reports, magazines, and journals downloadable from website. Bell (2005) and Fisher (2007) consistent search criteria had been used on different websites for companies data, business news and business journals. Researching resources of British Library (BL) website provided a firm research framework of literatures review. The nature of the research study was theoretical and this dissertation would be judge on the basis of how much literature had been gathered. What sources were used to obtain required literary data by accessing venue of literature resources that is given in appendix A. How literature was reviewed critically in relation to academic research of CIA. ³We can all learn a great deal by reading what other researchers have done. Look critically at all reviews which come your way.´ (Bell 2005:110) ³BE CAREFUL in your selection of written source. The simple act of getting a book into print does not make the author an expert.´ (Kane 1983:98). White


Dissertation ± Chapter 2 METHODOLOGY

(2002), Bell (2005) and, Fisher (2007) the research had importance for critically relevant literature review from books and downloaded PDF file from online resources of different websites for citing case studies. Suggested data of good qualitative standard from online resources was prepared. This data base was categorically organised for bibliographic referencing. Researcher had stored more than 60 items of mix books and thesis papers, article, and working paper. ³You should spend some time becoming familiar with all the services that your university or institutional library can provide by exploring both the physical library and the virtual library´ (Fisher 2007:97) the online books searched through BL integrated catalogue website using the search phrase ³Investment Appraisal´ or ³Capital Investment Appraisal.´ BL website was also used for online journals, articles, news articles, case studies, and other associate websites that contains useful information and valuable referencing for CIA. The data base of online resources had more than 80 items out of those some are of low relevance but most are significantly important but not all could be referenced in dissertation. The list of read authors for their contribution to CIA by their perspective of different aspects was exhaustive. Researcher had been selective in considering their work for research reference. Researcher should also had the system to guard himself from any accusation of cheating or academic impropriety ³It might be worthwhile to check up on the Harvard system of referencing... before you start collecting material then you be sure to record all the necessary bibliographic detail as you identify the books and papers.´ (Fisher 2007:100) with Harvard style of referencing the authentic bibliographic had confirmed essential validity and reliability of research methodology. White (2002) the direct citations were not always necessary to be quoted in this dissertation where indirect references given were appropriate by paraphrasing. (Bell 2005) the researcher found it very relevant and critical to establish the fact of the research supporting argument using witting and unwitting quotations from literature reviews. The researcher¶s literature review is critically distinguish and elaborated as compare to other fellow dissertators. It had come to suggestion from researcher¶s supervisor to expand the literature review in the final dissertation. It was also recommended officially in dissertation guideline that an extensive literature review need to be done for


Dissertation ± Chapter 2 METHODOLOGY

covering all required aspects of selected topic. Addition to that it should comprehend any seen or unforeseen shortage for research design.

2.2.3 Sampling Method: Gathered and reviewed the non random, purposive, and critically relevant literatures of CIA through distinguish literary sources of secondary data. ³Case studies, which are generally considered to be qualitative studies ...´ (Bell 2005:115) this also refers as internal data which is available inside CIA¶s case studies of organizations. That was considered as only qualitative data which researcher had gathered from his primary research scheme of academic work. It was actually the research sampling method for CIA for academic nature of the study and desk based style of research. That is why the collection of primary data with the help of survey questionnaires or interviews was rejected. ³A knowledge of what gone before will give you a µstate-of-the-art¶ background´ (White 2002:86) what was most important in methodology from the gathered pool of literature data is the selection of source by the researcher in referencing his study for successful argument for the research question of CIA misapplication and mismanagement to achieve the set objective.


Dissertation ± Chapter 3 LITERATURE REVIEW


The CIA literature review has been divided by two main parts, the first parts has its technical theory, model and application which combines with the second part which have its complex issues of uncertainty, discrepancy, and inconsistency for private large enterprises. Lumby and Jones (1999) the capital investment takes place for tangible household¶s assets in a production of capital goods by manufacturing plant, machinery, automobile, and other physical assets. Confusion to be avoided between capital investment and financial investment and also between capital and financial therefore researcher would like to quote the fact from the statement that, ³The term financial investment relates to investment in securities, and capital investment to investment in productive goods such as, e.g plants, building and machines´ Segelod¶s (1991:36-37). Books explained common models of CIA which researcher would examin as theories. These are the basic ground for research analysis because these are CIA applications use by investor in England. The weakness by uncertainty, discrepancy, and inconsistency in CIA could not be synthesized without basic knowledge of CIA theories. The published trend of CIA literature can be summarised such as CIMA published book by West and Stein (1997) and Busby and Pitts (1998) have discussed common capital investment techniques, Gardner (1997) and (1998) presented his knowledge in multiple workbooks, Lumby and Jones (2001) worked diligently in Fundamentals of Investment Appraisal and in (1999) Investment Appraisal & Financial Decision, the techniques have been presented in a holistic study by Azzopardi (2004). The view of writers discussed to cordon all study aspects for flawless research, where the conflicts in CIA literature review have been found. These conflict of theories were given by Segelod (1991), Lucey (1971), Lumby and Jones (2003),Mott (1987), Moran (2000), Dayananda (2002), Robicheck (1965), Baddeley (2006), Llewellyn (2005), Magdy and Dugdale (2001), Smit and Trigeorgis (1995), Datamonitor (2005), Buckle (2005), Strong and Appleyard (1992), Farrar (1967), Götze (2008c), Harrison (1973), Holmes (1998) and Dixon (1994). Literature available in other than CIA such as investment portfolios of


Dissertation ± Chapter 3 LITERATURE REVIEW

capital markets and investment in public sector were exclusive to study unless it was compulsory and complementary for research.



combination of CIA¶s theories, models, and it financial application would be taken into consideration by researcher in such a way that these would become a network for coherent CIA synthesizes. The theories would be explained first on the basis of CIA literature reviews and the best sources are books. The theories follow by advance models which have contemporary approaches based on the basic models those were explained as theories of CIA by the researcher. The various advance models have been given by financial experts on behalf of the organization, especially by the financial institutions. Finally the important part of entire exercise is the application of different financial options after exposing different theories and models of CIA.

3.1.1 THE THEORIES OF CIA: The conceptual process CIA techniques are detailed and complicated. The appendix B has a full list of acronym that has been used in the study. There are many text books which have explained how the technique of CIA works. ³Capital investment appraisal techniques generally involve comparison between the projected cash outflow to recognise changes in the time value of money, or may be based on unadjusted cash flow.´ (West and Stein 1997:5) A brief example can be reference from CIA case studies in a seminar for ³Major Project Investment Appraisal.´ Example of CIA: ³The Abu Dhabi National Oil Company project was valued at about $30 million and had to be completed over a period of 28 months from date of order.´ (Putterill 1981:4) The fundamental theoretical models of CIA leading for capital investment planning of decision making are discussed in following chronological order;


The Payback Period (PP): Lumby and Jones (2001) this is a most simple

and well known CIA technique to prefer any individual project on the basis of


Dissertation ± Chapter 3 LITERATURE REVIEW

estimated time of return for an investment in form of cash flow. This method prefers the liquidity over profitability in investment of project. Table 1 is given below to demonstrate two comparative projects with different cash inflows for same payback period. TABLE 1: Illustration of Payback Method PROJECT (£m) A B (80) (20) 35 10 25 8 20 6 20 4 10 4 TOTAL PAYBACK PROJECT (£m) A B

YEAR 0 1 2 3 4 4

DESCRIPTION Initial Cost Cash Inflow Cash Inflow Cash Inflow (Payback Year) Cash Inflow Expected Residual Value Initial Cost Gain On Investment



(80) 0

(20) 4

(Source: Kaplan Financial)

The rule of payback period for decision making is indifference because either project was investment worthy. Mott (1987c) project B has a faster µspeed of payback¶ for achieving quicker BE point and less risky for return on of capital.


Accounting Rate of Return (ARR): It is an acronym for accounting rate of

return which is a rate of return percentage for project appraisal. The project approval standard for CIA is a higher ARR as compare to a known targeted return on investment (ROI). The ROI can be measure by financial statement analysis using a ratio of profit and long term capital employed. Lumby and Jones (2001) it is also known as return on capital employed (ROCE) among many other similar types of names. The calculation of ROCE could be done from financial statement of the company by an income statement item which is profit (income) and an item of balance sheet which is capital employed. Comparing ARR by the firm¶s targeted rate of return commonly known as ROI/ROCE. It has to be less than ARR of the project for the CIA. The ARR depends upon average investment of initial investment and residual value of the project. The mathematical presentation of basic average investment given as; 11

Dissertation ± Chapter 3 LITERATURE REVIEW

Formula 1: Average Investment Average Investment = Initial Investment + Residual Value of Project 2 2
(Source: CECOS NQF level 7)

The calculation of ARR using average profit as percentage for average investment or initial investment has been represented in the following equations respectively; Formula 2: Accounting Rate of Return ARR = Average Profit x 100 Average Investment Formula 3: Accounting Rate of Return ARR = Average Profit x 100 Initial Investment

(Source: CECOS NQF level 7)

A higher average investment or initial investment would give a lower ARR and a lower average or initial investments would calculate a high ARR percentage. The project invested considering ARR criteria of investment would have a minimum average investment or initial investment as well as a minimum residual value for maximum average profit. The illustration of two projects that considering ARR for CIA technique given in table 2. TABLE 2: Illustration of Accounting Rate of Return (ARR) YEAR 1 2 3 4 PROJECT (£m) A B Cash Inflow 35 10 Cash Inflow 25 8 Cash Inflow 20 6 Cash Inflow 20 4 Total Cash Inflow 100 28 Initial Cost 80 20 Expected Residual Value 10 4 Average Investment 45 12 Average Profit 25 7 ARR= Average Profit/Average Investment X 100 55.56% 58.33% Initial Cost Less Expected Residual Value 70 16 Estimated Annual Profit 30 12 Estimated Average Annual Profit 7.50 3.00 ARR=Estimated Average Profit/Initial Investment X 100 9.38% 15.00% ARR= Estimated Average Profit/Average Investment X 100 16.67% 25.00% DESCRIPTION


(Source: CECOS NQF level 7)


Dissertation ± Chapter 3 LITERATURE REVIEW

The project B is the choice for investment in above illustration by virtue of low initial cost and low average investment resulted in a higher percentage of ARR.


Weighted Average Cost of Capital (WACC): It is not a method instead it

is actually a firm¶s own internal discount rate which could be calculated from derived formula of WACC, given below as; Formula 4: weighted Average Cost of Capital (WACC) WACC = (Total Loans % X Interest Rate %) + (Total Equity % X Profit on Equity %)

(Source: Gardner 1998a ± Capital investment appraisal workbook 18)

The 7.1 case study is given in Moran (2000) for finding new WACC after circumstances had change for Lever ltd. The hypothetical illustration of WACC for two mutually exclusive projects in a firm with two cash inlays discounted by same WACC is shown in table 2. TABLE 3: Illustration of Weighted Average Cost of Capital (WACC) WEIGHTED AVERAGE COST OF CAPITAL @ 10% PROJECT A PROJECT B (£m) (£m) -50 -50 -30 -30 20 18.18 8 7.272 15 12.39 5 4.13 15 11.265 5 3.755 15 10.245 5 3.415 15 9.315 5 3.105 8 4.968 7 4.347 16.363 -3.976

YEAR 0 1 2 3 4 5

DESCRIPTION Initial Cost Cash Inflow Cash Inflow Cash Inflow Cash Inflow Cash Inflow Expected Residual Value NPV

(No Source: Hypothetical Assumption by Researcher)

Project µA¶ would be making profit @ 10% of WACC, because the NPV is positive. Project µB¶ is not feasible due to negative NPV for the same firm of lower forecasted cash inflow. It is concluded that WACC is actually a discount


Dissertation ± Chapter 3 LITERATURE REVIEW

rate therefore one project may be acceptable for one firm which may be rejected by another firm for different WACC which could is variable between firms.


Discounted Cash Flow (DCF): The Discounted cash flow is a technique of

finding the present value of money by using discount factor. The discounted cash flow has two basic discounting techniques categorise as net present value (NPV) and internal rate of return (IRR). Both of these techniques use cash flow discounting by using discount factor with an applied discount rate. ³The time value of money is taken into account through the discounting process.´ Lumby and Jones (2001:77) the idea of DCF is converging all cash flows of a project to a particular point in time for valuation of money. The present value (PV) of money in term of future ROI and the future value (FV) which is also term as compounding mathematically represented as; Formula 5: Future value (FV) FV = PV (1 + r)
(Source: CECOS NQF level 7)

For present value PV would be given as; Formula 6: Present value (PV) PV = FV x 1 1

(1 + r) PV = FV x (1 + r)
(Source: CECOS NQF level 7)

Where µ r¶ is the interest rate or discount rate and n is the number of years for the period of investment. The term discounted cash flow used because discount factor (1 + r) is applied for converting FV in to PV. It is imperative for researcher to

explain that discount factor of cash flow in DCF so the readers would have a basic idea of DCF therefore understanding of NPV and IRR would be easy of detailed explanation of reoccurring terms.


Dissertation ± Chapter 3 LITERATURE REVIEW

Cash Flow by Discount Factor: The executives response to the role of corporate treasury department was stated that, ³it supports the business by providing adequate liquidity and cash management services.´ (Tanega et al 1997:4) the case studies for corporate treasury department signify the liquidity for cash flow in firms. Here it is explain briefly that cash flow could either mean as cash inflow or cash outflow depend upon the investment situation, if it is an investment than it is generally a cash inflow after the first cash outlay in the form of initial investment or any other cash outflow of reinvestment. The discount factor is mathematical factor of (1 + r) which discounts the cash flow to estimate the FV of money in

present time. The both PV and FV of investment can be calculated with the variable treatment of formula. There is some useful information has been given for PV table in appendix C in which discount factor has been used.


Net Present Value (NPV): Pike and Arnold cited in (Taziralis et al 2009)

consider NPV is a most common method used by British private enterprises. NPV calculates the value of future cash flow for present time value. Individual present values are products of future forecasted cash flows and discount factor from present value table. West and Stein (1997) also defined NPV as summation of all individual present values and excluding the initial investment to achieve the NPV. PV of initial investment of the project is prior to 1st year¶s cash flow therefore 1 corresponding value of discount factor has to be use. The PV at 0 year has to be negative for initial cash outlay for an investment. TABLE 4: Illustration of Net Present Value YEAR 0 1 2 3 CASH FLOWS DISCOUNT FACTOR (10%) 1 0.909 0.826 0.751 PRESENT VALUE (PV) (10,000) 2,727 4,543 3,755 1,025

(10,000) 3,000 5,500 5,000 13,500 NET PRESENT VALUE (NPV) 1,025

(Source: CECOS NQF level 7)


Dissertation ± Chapter 3 LITERATURE REVIEW

A different example of Expansion ltd case study is given by Mott (1987c) which has annuity for four years. Please refer to the additional information about the NPV for annuity and perpetuity calculation in appendix C.


Internal Rate of Return (IRR - Yield): The IRR which is an actual return

on investment uses the linear interpolation as formula for IRR. The linear interpolation requires NPV of at least two or more mutually exclusive projects. The NPV of mutually exclusive projects ascertain by their discount rates. Than the determined values of NPV and the discount rates of the projects would be plug in the following equation of linear interpolation; Formula 7: Internal Rate of Return (IRR) IRR = a + NPVa (b - a) NPVa ± NPVb
(Source: CECOS NQF level 7)

The resultant IRR is the discount rate at which NPV of the project will be zero. Lucey (1971) demonstrated that the (Yield) IRR has to be higher than the highest required ROI which is the applied discount rate at which the discount factor is used to calculate NPV. Table 6 and 7 of exclusive project A and B respectively shows the computation of IRR for different discount rates, where the condition of positive NPV had always exist. ³This rate is normally calculated by trail-and-error process using computer package.´ (Dayananda 2002:96) different discount rates for a project has to be check by trial and error method because a higher IRR as compare to the highest applied rate would be selected for CIA only after getting a positive NPV.


Dissertation ± Chapter 3 LITERATURE REVIEW

TABLE 5: Net Present Value at Lower Discount Rate (NPVa) PROJECT A (£m) DISCOUNT CASH PRESENT FACTOR FLOW VALUE @ 10% (80) 1 (80) 35 0.909 31.82 25 0.826 20.65 20 0.751 15.02 20 0.683 13.66 10 10.00 11.15

YEAR 0 1 2 3 4 4

DESCRIPTION Initial Cost Cash Inflow Cash Inflow Cash Inflow Cash Inflow Expected Residual Value Net Present Value (NPVa)

(Source: CECOS NQF level 7)

TABLE 6: Net Present Value at Higher Discount Rate (NPVb) PROJECT B (£m) DISCOUNT CASH PRESENT FACTOR FLOW VALUE @ 17% (20) 1 (20) 10 0.855 9 8 0.731 6 6 0.624 4 4 0.534 2 4 4 4.28

YEAR 0 1 2 3 4 4

DESCRIPTION Initial Cost Cash Inflow Cash Inflow Cash Inflow Cash Inflow Expected Residual Value Net Present Value (NPVb)

(Source: CECOS NQF level 7)

a = Lower Discount Rate (10%) b = Higher Discount Rate (17%) Formula 8: Linear Interpolation IRR = a + NPVa NPVa - NPVb
(Source: CECOS NQF level 7)

(b - a)

The researcher can find IRR by substituting the values of NPVs and discount rates in linear interpolation; IRR = 10% + 11.15 (17% - 10%) 11.15 ± 1.36


Dissertation ± Chapter 3 LITERATURE REVIEW

IRR = 17.97% § 18% The calculated IRR is greater than the highest applied rate of return which is used as b = 17% in linear interpolation.


Benefit & Cost Analysis (BCA) and Profitability Index (PI): The

benefit/cost analysis highly recommended for government or semi government organization to develop mass project which can only be finance by government in the interest of public well being and safety. Sometime Cost-Benefit Analysis is used as an alternative description for investment appraisal. However strictly speaking, it is the term used for the wider investment appraisal conducted by public bodies when considering, for example, whether a new bypass should be built or a hospital extended. (Moran 2000:16) The researcher have analysed this technique for private organization that would be the stake holders in a massive project such as TfL which shares its bus route to different company and the largest stakeholder is Arriva. BCA similar to PI allowing a comparison of benefit to cost in capital investment decision making as PI comparison does for NPV and initial cost. If the ratio between benefit and cost is more than one it identify that the project has more benefits than its cost so project can be accepted. PI is the factor of NPV out of initial investment for the first year of the project. The basic criterion for investment remains the same as BCA that the PI has to be more than one. A case study 6.3 on page 150 (Moran 2000) of Tellymore Ltd suggested that in capital budget constrained the best use of a CIA technique is PI. Formula 9: Profitability Index Profitability Index =
(Source: Moran 2000:61)

Net Present Value of Cash Initial Cash Outflow


Dissertation ± Chapter 3 LITERATURE REVIEW

3.1.2 THE MODELS OF CIA: The majority of advance models in CIA have cost of capital approaches. The other models have different other effecting factor for the application. The researcher opted for CIA implications for the study so the effect on cost of capital would also be research instead just studying the effect of capital employed on real and financial options.


Models On Cost Of Capital: Researcher has learnt various advance models

on cost of capital during this research, some of those described by Gardner (1998a) and later briefly explained that, ³Undertaken a project which does not offer a return to the business greater than it own cost of capital will mean that the company will lose money on that project and find it more difficult to pay interest and dividends´. (Gardner 1998c:16) cost of capital is the total assets that a firm hold for its business routine. The general breakup of cost of capital is equity, retained earnings, long and short term debt, the allowance for depreciation also has an effect on the retained earning so it also forms a part in cost of capital. The best example of any application which in primarily based on cost of capital or taken cost of capital in evaluating the capital investment is the WACC. ³weighted average of the costs of all the source of capital which are used by the firm.´ (Hawkins & Pearce 1971:46) WACC is the discount rate of the firm that could not be called a model of CIA for investing in any project. The present condition in England is not very congenial to support any model on cost of capital because the banks want higher return from their borrowers on the investment in the form of return on equity. A case study conducted in 2005 claims that the British banking system has higher profitability then in the continental region of Europe. The British banks case study states that, ³Thus, notwithstanding that the British banking industry shows signs of strong competitive conditions, excess returns are being earned.´ (Llewellyn 2005:279-280) since the excess returns are in practice for more than 15 years since 1995. The competitive market forces have not much concern to reduce pressure from the cost of capital by lowering high return on equity (ROE). So this is evident before researcher look into any models on cost of capital that it is tougher to a large private organization in England to adapt any such model which has excess payout in the form of ROE than COC. The emphatic


Dissertation ± Chapter 3 LITERATURE REVIEW

comment of the JP Morgan president Chase Europe, Sir Andrew Crockett in supporting the idea of British banking system of increasing shareholder value with higher ROE. He also suggested avoiding other European banking strategy of mixing with stakeholder value to protect cost of capital in the businesses.

The first two models are fundamentally same for the purpose of liquidating the assets to clear company¶s debts. The practicing higher ROE by British banks compare to company¶s COC would not help asset valuation of the firm for loan repayment. So these models are not practically favouring the capital investments in short term. In long term the volatility of market and forecasting of assets valuation should be consider carefully. 1a. JP Morgan Models on Cost of Default & Black-Scholes Option Pricing

Model: The Black-Scholes model is adopted by Merton 1974 to put option at strike prise which is the value of the loan in the form of liab ility. So when a company default while the total value of assets is less than its total liability then the bank write off company total debts by liquidating all its assets for settling the total. In the case of aroused assets the bank will recover full of its debts against any outstanding of total liability. The case study stated that, ³JP Morgan has adjusted the Black-Scholes model in an attempt to measure credit default risk.´ (Gardner 1998b:9) there is no difference between Black-Scholes Option Pricing model and JP Morgan model. The similarity in both models is the put option at strike except some minor adjustment to JP Morgan model on cost of default. Black Scholes Model recommends risk free investment but a case study of Baring Delta Hedging Gardner (1998b) suggested that there is high risk in the business when there is too much volatility in market.


Economic Value Added Model: Managers have to be given bonuses on the

basis of performance for increasing total value to the capital. The rewarding bonus would be on the added value of capital. This type of model is suitable for marketing firm where sales target has to meet. This is not a very functional model for CIA due to its functionality of enhancing the value of existing capital


Dissertation ± Chapter 3 LITERATURE REVIEW

employed rather than support the process of the new investment plan. Gardner (1998c) it measures annually on the basis of difference in return that has achieved and the return that suppose to achieve by set target. It cannot easily fit with any technique of CIA instead it could be use for cash flow forecasting. A more realistic model for economic value added reasoning to CIA would be the model of rationality which preconceives the ideal condition of capital investment. Researcher recommends the economic added model as a contingency model for new product line market segmentation for the product diversification. Economic value added model is a measure of remedy for declining in sales.


Other Models: The following models are not based on cost of capital but

they can impact on capital and equity. The cost of capital has been a corner stone in fundamentals of CIA. This statement is very relevant for that, ³The cost of capital is, effectively, the amount it has to pay for its capital in term of interest and dividends.´ (Gardner 1998c:16)


Modigliani and Miller (MM) Model: The MM model assumes that if there

is no uncertainty and the market is perfect than the firm would not have any difference for his debt and equity. Therefore the value of shareholder¶s stocks could be increase by using the company¶s loan judiciously for capital. Based on MM model it was argued that, ³we can ask whether there is some combination of debt and equity which will, ceteris paribus, maximize the stockholders¶ value per share.´ (Robicheck 1965:21) the hypothetical testing of this model was in the absence of taxation on corporate income. ³However, tax is not based on net cash flow, but on taxable income.´ (Dayananda 2002:18) this is the fundamental model for assumption of cash flows forecasting in relation to taxation. ³in the absence of taxes on corporate income, the value of a firm is independent of the proportion of debt to total capitalization.´ (Robicheck 1965:21) this model would be further referred in implication of taxation during evaluation of CIA performance for firms England. A large amount of tax is payable by firm¶s for the expected income from forecasted for cash inflows. However there is serious criticism for assuming no uncertainty. The rate of borrowing would be high for loan utilise as equity where


Dissertation ± Chapter 3 LITERATURE REVIEW

using loan as equity has to match the capital market rate of interest. The risk of uncertainty would be surging the ROI by variation in interest rate.


Capital Asset Pricing Model (CAPM): This model in based on the

sophisticated relationship between expected risk and expected ROI. It is logical that a high risk project would have high level of profitability. This model was given by Sharpe Lintner and Mossin in 1964 states the investor tendency to invest in the risk free assets which will return in the form of risk free return. This assumption is very difficult to adopt as it is states ³Risk-adverse investor, however, will tend to put more money into risk-free assets...´ (Gardner 1998b:24) CAPM suggest investing in the project with no or low risk involve by analysing the risk of asset on optimal combination. The Security Market Line (SML) that would be referring in implication of taxation also derived from this model.


Advance Manufacturing Technology (AMT) Model: The fuzzy set theory

of triangular number in advance manufacturing technology was modified by Magdy and Dugdale (2001) after they have found the flaw of linguistic scale (LS) in the previous fuzzy model. It is based on three dimension triangular approach of risk i.e. uncertainty, financial return, and non financial factor. The authors of the model describe in their papers that the existing models of CIA need to be improve to cater the intangible benefits. These benefits are in the form of production flexibility, quality improvement and employee morale. The term fuzzy in AMT investment projects represent the ambiguity in high yielding. Gardner (1997a) there are also nine prices patterns available for market price which are use in capital market of fuzzy logic system. It only recommended for investors who are interested for an AMT investment. The decision is based on market data available such as ³A putty Clay technology Case´ by (Kon 1980) for capital input choice under uncertainty. The case fulfils the conditions of triangulation of fuzzy set theory.


Models of Rationality: The model has a link to what writer mentioned as

real world investment appraisal that is CIA techniques. This model is based on


Dissertation ± Chapter 3 LITERATURE REVIEW

DFC technique which is link to fixed asset investment theory of Jorgenson 1963, who used the Cobb Douglas production function (CDPF). This is straight forward modified technique based on NPV or IRR with the use algorithm for expected future achievement though constant gain in production. It was concluded by Das (1974) that the problem with algorithmic structure not easy to handle due to particularity of cases. Individual future expectation has difficult algorithmic structure to be adopted. It is an objective and subjective mixed approach to quantify the future growth of the production. The researcher classifies it as a method of calculated prediction for future production or sales linking with one of the most adapted and complicated DCF technique. The model has major flaw of neglecting uncertainty which author of the article admitted himself in stating that, ³Jorgensonian investment theorists developing this static approach neglect in their analysis two aspects of investment decisions: first, how uncertainty and expectations about the future affect decision-making strategies ...´ (Baddeley 2006:330) t he models virtually rationalize the firm¶s quantifiable expectation on the basis of rationality and achievement of targets. Helliwel (1976) stated that the hypothesis by Eisner and Nadiri turn out ratio of price/cost was less than 1 and in some cases it was zero, which is against the research by Jorgenson. This hypothesis has been tested by the Cambridgeshire Manufacturing firms. The practical application of this model found as a serious risk without considering uncertainty. A firm with high level of growth can apply this model in CIA on substantive rationality but the moderate firms would avoid this model for the higher degree of risk associate to uncertainty. 3.1.3 THE APPLICATION OF CIA: The application of CIA would be discussed in the upcoming part of literature review that has significance of CIA application for England. This relationship would be elaborate in more detail on overall complex performance of CIA for private companies in England. At this stage the literatures review briefly outlook the CIA application option¶s flexibility and capital investment decision making. The application also establishing the relationship between theories, models to the existing discrepancy, uncertainty and, inconsistencies in coming literature review for CIA performance in England.


Dissertation ± Chapter 3 LITERATURE REVIEW


CIA Application Flexibility for Decision Making: The application

flexibility of CIA is the open options available under uncertainty. CIA flexibility options divided into two main categories of real and financial investment options. The interrelationship of real and financial options has been mentioned by Smit and Trigeorgis (1995). It was concluded by them that there is severe lacking of real options in DCF methods in contingent decision for intermediaries plans. Centre of Finance and Management Studies, University of London (200?) stated that finacial investment flexibilty is independent to flexibility of real investment after taken real option in effect. Researcher agreed that financial flexibility depends on real option available such as valuation tool of capital and real assets. The open option flexibility is the delaying phenomenon in the state of hibernation for decision making. This is the monitoring and elimination process for any decision mistakes that would be done without availing the available open options strategically. Financial and real options of flexible capital investment indicate that how and why decision can be flexible. An irreversible capital invest ment decision of real investment can be safe guarded by any mistaken decision of selling capital equipment for resource capitalization. Five items to value flexibility given as; ³The cost of exercising the options, the current value of the project in the absence of flexibility, the risk-free rate of interest, the life of option and, lastly, the uncertainty or volatility of the future outcome cash flow of the project.´ (Busby and Pitts 1998:vii)

The writers including Lucey (1971) of ³Investment Risk and Uncertainty´ had used the CIA techniques to explain that the uncertainty would always exist in a CIA process. For instance in payback period the arbitrary investment time horizon and return in the form of DCF that is directly related to financial market are the prime uncertain factors. CIA also has uncertainty for investment decisions due to different other factors of CIA application. The known uncertain factor could be helpful on the other hand in decision making with flexibilities. The decision for capital investment is primarily depends on the ROI by forecasted cash flow. There are some tools for supporting a decision by forecasting cash flows through determining of margin of safety (MOS) from vulnerability of deficit and profit


Dissertation ± Chapter 3 LITERATURE REVIEW

targets in a firm. The managing director may wish to apply other decision making tools of cost-volume-profit analysis and break even analysis. The case study of bank of America Investment (BAI) became Merrill lynch Global Wealth Management states that, ³nation's largest bank to realize the thus far elusive goal of providing retail customers a single place to stop for banking and brokerage services.´ (Hintze 2009:19) one stop financial shop a trading platform by Merrill Lynch and Bank of America has raise the concern of competing rival Morgan Stanley for delaying in their trading. The trading platform of Merrill Lynch gives joint access to their customer with banking and brokerage. This facility provided on real time quick access to capital market when decision making can be indifference for volatility. The advantages of decision analysing technique makes a care full decision in setting achievable targets. The project operation marginally safe with required cash inflows intact in any opted technique of CIA. After discussing the decision making tools for applications researcher should draw the attention of the reader towards CIA flexibility in uncertainty which is the root cause of other problem of application related with discrepancy and inconsistency. Appendix D has additional discussion for probabilistic treatment and simulation process of uncertainty.

Summary 3.1 The theories are the actual models of CIA that include Payback Period, Accounting Rate of Rate of Return, WACC, Discounted Cash Flow, Benefit Cost Ratio, and Profitability Index. There are two types of advance models of CIA, the model on cost of capital and other models for CIA flexibility. The brief discussion before section ends on application flexibility for decision making under uncertainty which will follow up with the next section in 3.2.


Dissertation ± Chapter 3 LITERATURE REVIEW



researcher has explained briefly the application of CIA with its build-in uncertainty in 3.1.3. This analysis of CIA application is for CIA performance in England. This is researcher second objective which is closely link to the research question of CIA misapplication and mismanagement for private sector in England. The researcher has an analytical importance of applications to evaluate the complex performance of CIA in large scale businesses of England for the discrepancies, uncertainties, and inconsistencies. The overall area of CIA application has confined the other overlapping areas of CIA theories, models, and misapplication and mismanagement (M&M). Graphical presentation of figure 1 for evaluation of complex CIA application performance in England is technically difficult. It is mentioned that, ³how Merrill Lynch, Citibank, and JP Morgan could have shelled out tens of billions ..... by analyzing data sets that give little or no information on business situations or practices.´ (Bergmann 2009:279) the researcher needs to explain thoroughly why the case is and how he would justify his finding in Analysis and discussion.

FIGURE 1: Application of Capital Investment Appraisal (CIA) APPLICATION OF (CIA) CIA THEORIES




Dissertation ± Chapter 3 LITERATURE REVIEW

The researcher believes that the under examine applications have been discovered with weakness of discrepancy, uncertainty and, inconsistency. The researcher had make group factors of discrepancies, uncertainties and, inconsistencies to underpin all actual reasons of any M&M in CIA. Discrepancies in application are mainly due to complex and lengthy calculation to deal with incorporated uncertainty. Literature reviewed has been written by various writers for certain and uncertain factor of CIA financial options. Segelod (1991) criticised DCF technique because it is not always predictable for an investment to foresee the ROI in term of cash inflows. He also suggests that models for CIA would be insufficient for certainty without handling of unquantifiable risk. ³.. recent investment literature introduces uncertainty into the investment models.´ (Erdal 1997:14) therefore it would be uncertainty that the researcher have to examine closely for his study. The risk of uncertainty taken by a capital investment is affecting the decision making process. The higher degree of complex CIA has difficult decision making criteria due to the higher level risk of certainty and uncertainty. The decision on the basis of CIA should have to be consistent and implicating area of inconsistency has to be reduce to minimum level so CIA performance can be maximise for the project benefits. 3.2.1 THE DISCREPANCIES OF CIA: The Company¶s funds are protected by the company act which states that, ³There are some 60 offences contained in the companies Act 1985 which are aimed at protecting the investor.´ (Fairplace Institute of Banking & Finance 1998d:20) the entire responsibility lies with the director of the company to make sure that the investor¶s money has been manage by proper management of the firm. Datamonitor (2005) Merrill Lynch has been successful in providing best services by the ³client management philosophy´ to its client with managing its client¶s funds. This was in case studies of Merrill lynch GPC (Global Private Clients) and GMI (Global Market and Investment Banking). The ultimate investment decision in large organization solely depends on board of directors who invest in projects after approval from executives. The discrepancy reflects the mismanagement of investment in the project but it is originated from the misapplication.


Dissertation ± Chapter 3 LITERATURE REVIEW


Implication of Inflationary Error: The implication by error of Inflation

brings forward the other two errors. Lumby and Jones (2001) explain these errors as discrepancy in investment forecasting error and discount rate error. Because without estimating the significant rate of inflation for price change there would be complication in predicting the real cash flow. The change in rate of inflation or general prise changes is most likely resulted from change in financial market interest rate which writer¶s refer as capital market imperfection.


Investment Forecasting Error: It is stated that ³All investment decisions

are based on forecast which, in the majority of cases, will be subject to error to a greater or lesser degree.´ (Lucey 1971:18) the term investment forecasting generalizes the cash flow so the error generally associates with the investment forecasting is the error of cash flow forecasting that can reduce the profitability of the project and it is proportionate to discounted cash flow. Lucey (1971) used NPV technique for estimating of cash flow error. The NPV which is affiliated directly to cash flow so it was appropriate to use for the purpose. It was found that NPV had 20% of discrepant cash flow for the same proportionate of 20% mistaken forecasted cash flow. The case study by ex asset manager in JP Morgan and serving fund manager in Merrill Lynch, David J. Buckle stated The ³fundamental law of active management´ of Grinold and Kahn (1999) while suggested that, ³the active manager should maximise performance by maximising both the quality of the forecasting and the number of µbets¶.´ (Buckle 2005:21) Dayananda (2002) had given his sensitive remarks for cash flow forecasting that, ³most critically important task´ he stated for cash flows forecasting that, ³The reference is not to past or historical data, but to future data expected from proposed project.´ (Dayananda 2002:37) he has also elaborated on the methods for forecasting system that could be adopted for minimise error of cash flow forecasting such as;

1. 2.

The High Low Method The Scatter Diagrams for Correlation and Line of Best Fit


Dissertation ± Chapter 3 LITERATURE REVIEW


The Linear Regression Analysis by line equation of (Y = a + bx), correlation coefficient and coefficient of determination.


The Time Series Analysis with Trend, Seasonal Variation, Cyclical Variation, and Residual Variation.


Rate of Discount Error: The investment discount rate is the interest rate

available for capital borrowing. The reason of discount rate error is connected with context to inflationary effects. The instability of inflation rate is the actual cause of error for pre-accessing project. This error is directly related to the issue of investment. Higher interest rate is either result of current rate of inflation or overstating the discount rate for project approval. The concern of writers has been noted for deliberately applied high discount rate. Dimson and Marsh (1994) has cited that ³many UK companies may be using excessively high discount rates to appraise investments and, as a result, these companies are in danger of under investing.´ (Drury and Tayles 1997: 89) an overstated discount rate would paint a rosy picture for investment forecasting by applying high interest rate in discount factor for an investment which has comparative low interest rate in PV.


Implication of Taxations: The application also has implications by factor

of taxation. It would be inappropriate to estimate actual ROI without using the tool of taxation into the CIA technique. (Dayananda 2002) discussed the model for post tax cash inflows with mathematical programming approach of taxation. Four of these approaches have been forwarded by Berry and Dyson in their paper of 1979. They have discussed the simple, more complex, and further treatment in UK tax system. Their salient approaches are optimistic treatment, pessimistic treatment, Bukley¶s approach, and including interdependency in CIA. Another CIA benchmark application under uncertainty is Security Market Line (SML) which provides an equilibrium relationship between expected ROI with risk for an asset that has even fail to treat for the personal taxation. ³.. the standard procedure is to compute the relevant cash flow figure after corporation tax but before personal tax with the required return computed on a consistent basis.´ (Strong and Appleyard 1992:1) Bullock (?) stated a case study of the French dairy company


Dissertation ± Chapter 3 LITERATURE REVIEW

LENSA. The company had implication in government taxation during expansion to Great Britain. Southampton was favourable normal areas for investment and operations as compare to Brecon which supported by cash grant system for the extension of the development area. Beside this example there are other examples with case study in (Moran 2000) for implication of taxation in unit installation (Case 6.2: P 145), replacement of equipment (Case 6.6: P 162) and Office automation (Case 6.7: P 167). The models on cost of capital discuss by Gardner (1998a) were also influenced by taxation. Modigliani and Miller (MM) model has been criticised for account of taxation on deductable interest in capital. The model was also failed to account for cost of bankruptcy. Liquidation and legal chargers inclusive of tax have to be account for in case of winding up a business. 5) Investment Time Horizon: It is actually an investment horizon for

termination of investment. This is the end point of an investment that an investor foresees in the future. The corporate investor always relates investment time horizon to cost-benefit apparatus for project¶s worthwhile. The project planning department should plan projects proposals by using specification investment time horizon. The cost-benefit schedule is link to investment time horizon for finding out the benefits of the cost spend on the project. The project completion date is not an investment time horizon which could be used in CIA. This is confusing in assessing financial investment flexibility. The benefits of the project would be time delayed due to investment time horizon. The time horizon would be severely effecting capital investment as it can be seen in Fisher (2010) ³nine ways to avoid investment mistake.´ According to the report time horizon would also be implicating corporate investment. Any error would result in the form of discrepancy to profitability either by erroneously overcastted the cash inflow or understated the discount factor in DCF by dysfunctional approach of higher discount rate. This critical factor of planning also have a methodological impact on the financial investment planning emphasized by Centre of Finance and Management Studies, University of London (200?). Lucey (1971) has also recommended technical strategy by finite planning of investment time horizon to substantiate the higher risk of uncertainty.


Dissertation ± Chapter 3 LITERATURE REVIEW

3.2.2 THE UNCERTAINTIES OF CIA: Risk and Uncertainty for investments is a dilemma for CIA and it is similarly discuss by many authors. An anonymous broker (2004) has been cited in case study of LSE by the famous quotation that, ³Why do I have to have all my eggs in one basket?´ (Davis 2006:12). (Moran 2000) Researcher observed that uncertainty has the direct relationship to risk bearing for a certain investment. Any uncertain factors to which most of the writers refer as volatility of the investment must have to be eliminated or resolve before investment would have certainty of risk in decision making. A risk can be varying from certainty to uncertainty as it was state that, ³Capital expenditure decision can take place in condition ranging from certainty through to uncertainty.´ Lucey (1971:30). Segelod (1991) state that there are models of CIA which researcher identify in 3.1.2 in both type of situation of certainty and uncertainty. ³All investment projects involve some risk and uncertainty since future event can never be predicted with complete certainty.´ (National Economic Development Council 1969:12).


Woking Capital: A practical project could not be operational without the

financing the working capital. The cost of working capital has to be included in the initial and running cost of a project. It is equally important and recommended to estimate the working capital cost with investment time horizon of the project. The two case studies on page 266 by Atrill & McLaney (2005) describe the importance of estimating working capital. In first case study the Brambles Industry lost 14 million of delivery pallets each costing £10 during 2002 due to poor stock control. The second case cited for poor stock management by Wal Mart in over stocking during Christmas in 2002. The typical case of Wal-Mart is also mismanagement of stock inventory when the sale only rises to 12% but stock level rise to 10%. Lumby and Jones (2001) explain the traditional method of payback period which exclude working capital because a longer PP would have higher risk in cost recovery of working capital. In a shorter period the management is keen to estimate all costs within PP. Unlike PP the ARR takes full account of working capital.


Dissertation ± Chapter 3 LITERATURE REVIEW


Rate of Interest: An excessive discount rate which most likely to occur as

discrepancy is the result of uncertainty in capital market. Researcher has used both term interest and discount rate repeatedly to make reader aware that they both are same rate and it is very prominent feature for a CIA. The risk of interest rate remains certain for short term but in the long period it is very difficult to forecast it precisely. This is the main problem in for CIA application which is would become misapplication and also a case of mismanagement. The risk of uncertainty could affect any CIA technique but it is very significant for WACC and DCF because these are directly reflecting the interest rate in their application. An interest rate that may vary for borrower is an uncertain element of capital employed which has resourced from a financial institution or bank. Gardner (1997b) the uncertainty of interest on loan is higher for longer period depending upon the capital market trends, internal or external business situations and ROI. Gardner (1997a) in an example of orange county portfolio management the interest rate on loan was unpredictable even in short term that made orange county bankrupt. This had also been the same case of Saving and Lending industry in 1980s.


Gearing and Leverage: The dysfunctional decision making is the real

factor in opting any level of gearing in the firm. Marchica and Mura (2006) have tested a hypothesis in their working paper on the low leverage (LL) firms. It was confirmed by different models of investment testing specification. That when a firm remain LL firm for two to three years of transitory LL policy period. After LL Policy period it can become a resource borrower power (RBP) firm. A RBP firm have easy access in external capital market to introduce new issued debt for increasing the capital expenditure in the firm. A RBP firm is less expose to liquidation and bankruptcy then a LL firm. A low leverage firm can achieve financial flexibility for capital investment decision making by transforming itself to RBP firm by surviving for at least two to three years as LL firm. Gearing is the company borrowing from investment banks, private investors holding in company¶s stocks (loan stocks) and trade creditors. When a firm become highly geared than it would have higher risk for repayment bank loans, share holder¶s


Dissertation ± Chapter 3 LITERATURE REVIEW

interest on loan stocks, proposed dividends if promised, and payment for stocks purchased on credit. A heavy geared company would also have to pay higher interest rate in the form of risk premium so the project uncertainty would be higher for heavy geared firm. An example states that, ³in the early 1990s interest rates were high and a number of companies simply did not have enough cash to meet their debt-financing need.´ (Gardner 1998c:19) the case study of ³The Sock Shop´ by Gardner (1998a) suggest that high gearing is not recommended for immature companies where profitability is uncertain and risk of debt repayment is proportionally higher for high level of gear. Contrary to what writer has recommended as leverage for mature firm when number of shareholders are not many and income from profit is taxable after deduction of interest expenditure. 4) Rate of Inflation: The complication by the rate of inflation has been stated

for the fact that, ³it increase the uncertainty and makes more difficult the estimation of the future cash flow including sales revenue, operating costs and working capital requirements.´ Graham (1987c:77) there are two types of rates of inflation that may change the future layout of the cash flows. These are specific rate of inflation which deals by Current Purchasing Power (CPP) and general rate of inflation which respond to Current Cost Accounting (CCA). The CPP adjusts the general rate of price inflation for the income and capital value. CCA is the system for specific inflation rate for current value of asset in the firm. The adjustment in discount rate is for the nature of cash flow. The cash flow could either be in real or in nominal (money) terms. The simple rule should be followed by taking nominal discount rate for nominal cash flow and for real discount rate for real cash flow. The basic difference between real and nominal discount rate is that the real discount rate (r) does not take inflation (l) in to account for investment. Whereas money or nominal discount rate (m) has both types of inflation (l) that is general and specific for investment consideration. The nominal rate and real rate can adjusted by interrelationship given by Fisher in an equation;


Dissertation ± Chapter 3 LITERATURE REVIEW

Formula 10: Fisher Equation for Rates of Inflation (1 + Money Rate) = (1 + Real rate) (1 + Inflation) (1 + m) = (1 + r) (1 + l)
(Source: CECOS NQF level 7)

The assumption of discount rate adjustment indicates that when cash flow is nominal and discount rate is real then the discount rate should be inflated for monetary discount rate. If cash flow is real and discount rate is nominal then it should be deflated for real discount rate. How the UK enterprises are coping with inflationary problem in CIA stated in a detailed case study of investment appraisal and inflation. The survey report for the case of inflation consists of 81 respondents who have the top priority to eliminate uncertainty from capital investment. ³A number of respondent have stated that a major problem is uncertainty.... They

often feel that adjustments for inflation are insignificant if one consider the uncertainty inherent in the forecast that have to be made.´ (Westwick 1976:2) the implication for adjusting the discount rate for inflation is addition to the uncertainty for inflation rate. The reason of inflation is the scare resources in the present age and technological advancement is the source of survival. The certainty of any breakthrough in advancing the technology is questionable therefore general trend of inflation rate is increasing.


Value at Risk (VaR): The model of value at risk presented by Markowitz

in Gardner (1998b) which is a technique to find the standard deviation of the cash flows. VaR is a standard deviation of cash flow from its required position. Mathematically VaR is a square root of a variance in DCF divided by the total number of years for cash flows excluding first year (n-1). The variance is the square of difference for each cash flow (X) from its mean ( ). This is a method for estimating the maximum risk for an investment that can bear as a maximum loss on investment. VaR has been used for two mutually exclusive energy projects in a case study conducted by Taziralis et al (2009) for Wind Farm and Biomass Gasification Plant. The VaR is denoted by (beta) which determined that low

level of investment uncertainty for Wind Farm project. Gardner (1998b) the normal distribution for beta can be varying according to desire of investing 34

Dissertation ± Chapter 3 LITERATURE REVIEW

authorities. Higher beta may have higher standard deviation and high risk of investment. The bank charges higher premium for higher beta because the VaR of investment is extended with increasing standard deviation of cash flows. The case study for Bank of America stated by (Jorion 2001c:388) that the beta was 0.03 which made the BOA (Merrill Lynch) AA credit rated bank. The beta can be calculated from the given equation for VaR
Formula 11: Value at Risk (Beta)  



Company Merger, Acquisition, and Joint Venture: The objective for

merging two firms could not always be profitability. It was often found that the firm which took over had difficulties is managing the new acquired firm because the share prise often fall below then current stock prise. A case study 1.1 states that, ³The senior management of the company does not believe that acquisitions of competitive companies are an appropriate way to grow the business.´ (Moran 2000:8) the reason was further explained with supported case study 1.2 on page 9. Gardner (1998a) quoted the acquisition of newspaper Observer by Guardian with the prospect of synergy by new incorporated management and skills of experience people from the observer. Unfortunately the absorption was not profitable because the absorbing company had only been able to acquire the new firm by issuance of loan stock convertible to ordinary share. The board of direct had to consider their decision by forecasting the cash flow as well as limitation of stock issuance to comparative worth of company assets which will not dilute it to the liquidity of less than net worth of assets. Case study of Jones plc is given on page 27 on workbook 18 by Gardner (1998a) on the assumption if unfortunately the bid for expansion to acquire a Swiss firm in Ireland would fail then the stock prise of acquiring firm would also be decrease and Jones plc would have to pay bond holder in form of ordinary shares which luckily did not happened in Jones Plc. In the case study of Credit Suisse gives an example of unsuccessful joint venture between Merrill Lynch and HSBC in IT on 50/50 basis. MLHSBC (Merrill Lynch and HSBC) have detail of IT corporation case that,


Dissertation ± Chapter 3 LITERATURE REVIEW

The MLHSBC joint venture demonstrates that even two of the world¶s largest financial institutions can get things very wrong when looking for new business. MLHSBC was set up in 2001 offering online financial services aimed at self-directed mass-affluent investors. (Datamonitor 2005:10) The failed scheme proved that the giants could even go wrong for a single project of high probability of success. The best possible corporation was unsuccessful without assessing the uncertainty of the project.


Decision Uncertainty: When the management is indifferent in decision

making for mutually exclusive investment plan due to forecasting of identical cash flows or similar ROI. In these situations decision has to be delayed for keeping the decision option open. Appropriate CIA technique can make an indifference decision easy for management. It was stated in relevance that, Finance theory and financial analyst extract from real world only those items which are immediately relevant decision at hand, and attempt to ignore or freeze into position those variables which may be too complex or difficult to handle. (Dayananda 2002:92) So by keeping the decision options open the management would not be surrendering their option of decision. A project could become a low ROI in any situation of uncertainty. The uncertainty to investment can be tackle with the open option available in the form of real and financial option of flexibility. These options either real or financial can be very helpful in decision making under uncertainty for single or mutually exclusive projects. To find out what are the best real and financial options available and when to implement them the deciding body would have to evaluate the risk and uncertainty involve in CIA. Farrar (1967) model of investment under uncertainty has based on the economic diminishing marginal utility of money. The model has the basic theory of investment in uncertainty from economic aspect but it is inconsistent with today¶s investment practice. The case study of four large enterprises (Roles Royes Plc, IDV, London Underground, and Post office Counter Ltd) has presented the common theme among the participant of ³uncertainty and fear´ (Grundy 1992:346)


Dissertation ± Chapter 3 LITERATURE REVIEW

3.2.3 THE INCONSISTENCIES OF CIA: Researcher has judged the inconsistency of each method for selection and ranking the projects. He has found inconsistencies in the decision criterion for CIA. Researcher has found that the inconsistencies have been predominant in the methods of which has impact of cash flows directly. The inconsistency is comparable between all CIA methods in their technique for ranking projects. The level of inconsistency is considerable less for the methods based on DCF. There is a basic separation for two categories of capital investment decision making. The authors have shown in their literature that the investment decision has to be taken either for single project or mutually exclusive projects. Dayananda (2002) the term mutually exclusive projects mean different project with same financial options available which would not interfere the financial option of other projects. In other words the ranking of acceptance would not be affected from the other project decision criterion on the basis of available financial options. The first check for inconsistency begins from the decision criterion of PP method which is based on cash flow;


Payback Period (PP): In this process the liquidity of the project taken into

account over a period of time. Individual or multiple projects can be appraised for investment on the basis of cash flow within calculated payback period. Lumby and Jones (2003) declared that it is the simplest method for investment estimation of projects without complicated factor of cash flows. The problem in this criteriaon is the liquidity that has been taken over the profitability of the project in decision making. Moran (2000) on page 47the inconsistancy was confirmed by a (3.1) case study of Easy Company Ltd. Nevertheless this method is recommended for breakeven analysis by achieving the ROI. It cannot really be considered as an investment appraisal technique because of its major defect: its inability to report the expected return over the whole life of an investment, through its disregard of the investment¶s post-payback period flows. (Lumby and Jones 2003:41) Writers pointed out ambiguity in this method for cash outlays as this would be the point of start for calculating period of payback of the projects in relation to cash flows. Another basis of inconsistency in the method is the evaluation of actual


Dissertation ± Chapter 3 LITERATURE REVIEW

ROI for longer period. The reason of this inconsistency is the absence of the investment time horizon due to the uncertainty of project life. ... the SPP Method, including the possible inconsistency between the assumption concerning the capital tie-up when determining interest cost ... and the average cash flow surpluses which are available for amortization according to SPP method. It must be emphasize that the SPP should not be used as an exclusive decision criterion because it fails to incorporate any profit or cash flow occurring after the payback period. (Götze et al 2008c:46) There is general disagreement among many writers for taken PP as a CIA method for the issues of inconsistencies. The PP is a uniform or stationary method of CIA that is mentioned with slight variation as SPP (Static Payback Period) which is acceptable for researche for considering payback method without discount rate. The very basic inconsistency in PP is the cash flow forecasting assumption. This assumption is based on the uncertainty of ROI and even by using sophisticated methods of cash flow forecasting it would not be possible to eliminate the uncertainty from forecasted cash flows. This inconsistency later had been carried forward to other methods which were modified inconsistently. The secondary condition of PP inconsistency is the lacking of discount rate for finding actual value of cash flows. This reason has the ground for setting aside PP as a method because it is incapable of overall evalution of ROI at termination of investment, that is investment time horizon which is similar in both authors opinion.


Accounting Rate of Return (ARR): Harrison (1973) this is first method

modified after payback period so it inherit all the assumption of inconsistency from PP and addition to those there are other factors that researcher has explained here. ³Another shortcoming associated with ROCE approach is that the choice of the minimum acceptable rate of return is arbitrary.´ (Holmes 1998:34) the targeted rate of return is the ROI or ROCE that is why this method normally refers as ROCE, ROI or ROR because the comparing methods to this technique is could be one of these. Screening ARR up against any return normally it is the ROCE of the firm that has not any authoritative method of calculation. ³There is no authoritative method of calculating capital employed or of defining profit.´ (Dixon 1994:25) the dual arbitration of targeted return and also investment time


Dissertation ± Chapter 3 LITERATURE REVIEW

horizon generally evaluated by writers that, this method has very low consistency so it should avoided for the reason give as; It should be consistent with intuition. Unfortunate, as in the case of the payback technique, it is all too easy to construct example where the use of the rate of return would either fail to lead to a decision, or lead to an obvious wrong decision. (Harrison 1973:40) The other factor after the investment time horizon which is missing is the discount rate that fail to assume the time value of money. It is another inherit defect of ARR from PP. The inconsistency can be seen in selecting both single and mutually exclusive projects. The calculation of ARR is same for individual and mutually exclusive projects. The criterion to select an individual project is the higher ARR than the targeted ROR. Preference for mutually exclusive projects is the higher ARR among all projects, that must also be higher than targeted ROR. This is a bias assumption for the project which has lower ARR because the cash flow may suggest that it has lower ARR but the PP is faster for early breakeven point achievement. This may be the project of instant return and longer investment horizon. The project of higher ARR could also have longer payback period for BE point and shorter investment time horizon. Researcher can support his point by altering the illustration in Table 3 of 3.1.1. By altering the table 3 the initial cost figure brought down to 60 (£m) for uniform cash flow of 20 (£m) for each year. In the absence investment time horizon another two years of cash inflow cannot be calculated in total cash flow which is biased for project (A). If the illustration remain unchanged given for ARR it would compliment the remarks that, ³the ROI approach would rank a 15 percent return on £100 for five years higher than a 14 per cent return on £10,000 for 20 years´ (Dixon 1994:2526) The researcher has explained in the theory the interdependency of ARR over the initial investment or average investment as well as residual value that he believe is the flaw in the technique that Dixon has mention. This is the case of inconsistency leading to discrepancy which caused by the uncertainty for investment.


Weighted Average Cost of Capital (WACC): Gardner (1998a) criticised

the inaccuracy of this calculative application for considering as a method. The


Dissertation ± Chapter 3 LITERATURE REVIEW

main criticism is for risk of profit against shareholder¶s capital and the gearing levels in the companies. The four major assumptions given by Lumby and Jones (2003) who stated that these assumptions must be hold good for NPV/WACC correct analysis. The assumptions states that; 1. The investment has to be marginal to capital employed. 2. The investment of the project should not alter the capital structure of the company. 3. Cash flow must be perpetual and; 4. The project risk should be same as company¶s own risk . ³Although three out of those four assumptions may be tough to cause real difficulty, one of the assumptions does have the potential to cause real problem: that of risk differences.´ (Lumby and Jones 2003:430) these assumption are very difficult to follow due to limited facilitation for the new or existing investment. The researcher would like to elaborate on the assumption of risk equality. The inconsistency in WACC is the limited assumption of risk bearing and using uncertainty to save the company¶s capital objective. This is too prudent approach in a investment worthy project. ´When a company moves into a new line of business which has very different level of systematic risk to existing business, then the WACC is not an appropriate measure of the discount rate.´ (Hol es m 1998: 131) in a nutshell WACC is not recommended for the business diversification where risk of uncertainty is higher than low risk expansion of the existing business. According to Moran (2000) firms in long run would have difficulty to maintain satiability in WACC especially in high level of gearing and risk profitability. The condition for WACC stand afirm when a firm paying off its borrowed capital known as gearing after reaching to a maximum profitability. As a result to this the interest rate would be kept low by the banks. The existing shareholder can also be attracted at the same time for holding the company¶s stock for longer period against lucrative dividends. As a result of maximise profit a project of low internal rate of return could be appraised for capital investment.


Discounted Cash Flows (DCF): The following two methods of DCF are

complicated because within each of these NPV and IRR methods the discount


Dissertation ± Chapter 3 LITERATURE REVIEW

factor has been a complicated issue for separating the objectivity of two DCF technique. The NPV is regarded as well know and most commonly use method in theory and also a largely practicing methods of CIA in England. National Economic Development Council (1969) this cannot be considers for the argument that NPV has low inconsistency or no inconsistency at all. Harrison (1973) the inconsistency in NPV can be seen in the case of PQR company where two simultaneous project were consider either for the purchase of new computer system or hire on lease. The calculation has shown on the page 52 in table 5.2 for lowest NPV criterion at 10% and 15%. The inconsistency in calculating the individual cash flows for purchase option bring higher NPV after capital allowance of depreciation and taxation. Where as the option to lease the computer system had consistent cash layouts. The NPV also based on forecasted cash flows with the assumption of specific time period as well as point in time. According to Lumby and Jones (2001) DCF has evolve with the modification of payback method by adapting time value of money concept. The utilization of discounted rate which is the added feature for uncertainty due to capital market imperfection. May et al (1991) in case of Birmingham integrated transport study (BITS) and a report from Anonymous (1983) for The Post Office¶s capital programme has used the basic criteria of positive NPV in accepting a project which recommends on the argument of a higher ROI by applied discount rate. The negative NPV could not be consider for a project acceptance. If the decision is indifference with an outcome of NPV equal to zero than management and board of director have difficult decision to make. A zero NPV also a discount rate at which actual ROI has taken place and it is the IRR. Therefore deciding body would have to consult other investment factors than sole NPV decision criterion. Such factor are initial investment and expected residual value for low average investment. In addition to DCF assumption given for NPV there are other assumption given by Götze et al (2008c) by those assumptions researcher asserts that NPV is an inconsistent method and sometime higher than IRR based on the assumption such as; 1. Single target measure by NPV is adequate, 2. The project economic life has to decide before investment. 3. Associate decision that are interdependent has to made before investment.


Dissertation ± Chapter 3 LITERATURE REVIEW

4. The validity of data is certain for investment forecasting; 5. The last very critical assumption for ³inexplicit of current and future investment´ makes NPV ambiguous. The last assumption is the violation of the of uncertainty assumption that could result in discrepancy of CIA using NPV for future cash flows. It is worth mentioning here that an advance model of rationality has been discuss in 3.1.1 which have been severely criticised in failing hypothesis testing for DCF and the neglecting uncertainty assumption. The above writer has the same assumption for IRR because it is also a DCF technique. Same assumption applies to IRR except the last assumption which has explicit criterion that allows the IRR to reinvest in the project through current or future investment. The whole inconsistence approach of DCF elicits at the last assumption. The main inconsistency in DCF has provoked the researcher for investigating the conflict which definitely has relationship with uncertainty.

Conflict in NPV vs. IRR: The selection criterion to prefer a single project using DCF¶s both techniques would remain simple and same for accepting a project with a positive NPV or higher IRR than applied interest rate. The single project inconsistency by zero value of NPV would be less serious than the complicated conflicting preferences for mutually exclusive projects between NPV and IRR. The best course of action in such situations is accepting the project of higher from larger NPVs for CIA. Choosing a higher of larger NPV over a higher IRR has the reason that NPV measures the actual increase in shareholder wealth for the cost of capital to be invested which (Moran 2000:3) represent as ³Thus the ultimate aim of new investment is to increase shareholder¶ wealth, by increasing the value of the company¶s shares on the stock market.´ The IRR is not as exact measure of ROI as NPV is, because IRR is a relative measure of ROI which calculates NPV to zero. Therefore a higher NPV of the lager value is recommended when both NPV and IRR give indifferent results for mutually exclusive projects.


Benefit & Cost Analysis (BCA) and Profitability Index (PI): These

methods of CIA are another comparable presentation of NPV to the initial cost of


Dissertation ± Chapter 3 LITERATURE REVIEW

the project. The inconsistance of the techniques found for misleading in the selecting mutually exclusive projects. The treatment for both of these techniques is similar for their association with NPV. The immediate step in both of the methods for decision criterion is the assessment of ratio between NPV with initial cash outflow or cost of the project. The drawback of BCA is the estimation of benefits because the project¶s benefits would be in the interest of public and not for the stakeholders. ³A more difficult problem, and one of more interest to the economist, is the evaluation of the cost and benefits.´ (Dixon 1994:125) even for government the estimation of public benefits is also a difficult task. Especially when investment horizon has to be judge for the calculation of project¶s benefits exactly. The case study of white rose consortium university of Leeds, Sheffield and York contradicted government in their report that ³However the relation of Government¶s overall objectives and the actual selection scheme to achieve them is unclear.´ (May et al 1991:4) the critical analysis was given by Moran (2000) when the initial cost is higher for a project of larger NPV in comparison to a project whose initial investment is low for expected NPV. That would make the resultant profitability index higher for later project oppose to the former project of larger NPV. The stated analysis for same NPV given here that, ³The first project would have a PI of 1000/300 = 3.3, while the second has a PI of 1000/500 = 2.0. PI often used in conjunction with NPV to resolve this kind of choices.´ (Harrison 1973:62) the ratio of PI is different for initial investments of the project. The inconsistancy of PI and BCA dependant on NPV and inittial cost or cost of the proect. The slection and ranking is misleading for mutually exclusive projects for different NPV and cost of the projects. 3.3 CONCLUSION OF LITERATURE REVIEW: Indebt debate of the study

and rigorous research around the topic conclude to researcher that there had been considerable academic researched made, particularly in CIA. There has been all sort of debate on model of investment with and without context of capital investment. Advance models on CIA were presented for the application flexibility. Each of the investment technique and latest models has it merit and demerit for decision making. The writers unanimously declared uncertainty as the


Dissertation ± Chapter 3 LITERATURE REVIEW

real manipulator. The research area in context of decision criterion for investment had been found with flaws and gap of CIA inconsistency. The inconsistent project selection process pressurise the private investor to deviate from the stipulated concepts of CIA. The interdependence of large companies in England for investing under CIA complex performance has been described by the group factors of uncertainty, discrepancy, and inconsistency. The central theme of the study remains with misapplication and mismanagement of CIA. The researcher dedicated this debate on the writer¶s written literature in books, journal and news articles. Summary for 3.2 Complex performance of CIA application in England has been literary reviewed. First followed by the group of discrepancies for inflation, forecasting, discount rate, implication of taxation and finally investment time horizon. The main emphasis on the study was over the uncertainty of group factor discussed for working capital, rate of interest, gearing, and leverages, rate of inflation, value at risk, investment for merger and acquisition and concluded with decision making uncertainty in CIA. The section 3.2.3 critically reviewed to compare the inconsistency due to gaps and flaws in actual theory and practice in the discussed techniques of basic models under the theories of CIA in 3.1.




The discussion is primarily based on the researcher¶s analytical findings through research methodology of critical literature review in this desk base study for which purposive qualitative observe data was collected. The researcher had done a beneficial research for logical outcome of the CIA recommendation that is completely interfaced with research discussion and conclusion. These

recommendations followed by suggestions have been justified from the researcher¶s extended critical literature review. The researcher must suggest for the readers to learn the recommendation and suggestion from various sources referenced for the first three objects of the study.









misapplication and mismanagement (M&M) in CIA is the valid argument for the discussing the analytical finding. By this discussion researcher can analyse the implications of financial options for CIA applications. The writers of the technical and financial aspect of the capital investment have common and cohesive approaches. Different writers had explained the process of CIA¶s techniques variably but similar concepts were used for same results. The researcher had described different written subjective and objective approaches of CIA theories, advance models, and financial options. These were critical analysed for research gaps and flaws that had open the drawback of financial weaknesses in the CIA. The models are incorporated with uncertainty which is the root cause of research question. Research conclusion of the findings after analytical discussion has the link to research question stated that, ³What are the possible implications of financial options in capital investment appraisal (CIA) misapplication and mismanagement for private sector businesses in England?´ The finding from the comprehensive literature review can be made available in the form of analytical findings.



4.1.1 Analytical Findings: Researcher has a long list of analytical findings for the very technical nature and research methodology of study. Researcher idea to treat the literary finding with discussion is recommended from the dissertation guideline in the absence of descriptive data. ³Your presentation of finding depends on the nature of your research.´ (Roberts 2004:174) the findings of this report is the analysis by reflecting the literature review with reference to research question and accomplished objectives. The first area in the body of knowledge is essential but not vary critical for analytical findings except the last part that is applications. However it cannot be entirely wiped out from CIA fundamentals analysis. The following bullets point would be discuss in detail as basic analytical findings. Analytical Finding of CIA Theories, Models, and Applications
y The PP method was the pioneer technique which later modified to ARR and

DCF. The latest evolve techniques were not consistent either.
y The theory of CIA that based on the DCF has the significance of discount rate or

discount factor.
y The cost of capital is the basis for judging company¶s strength for any

investment by borrowed funds from external sources.
y The theories of CIA which depends on the cost of capital are WACC and ARR.

Both of these methods are unstable for their limited assumption.
y The advance models are the contemporary procedures that have been modified

for specialized treatment of CIA by the financial experts. These advance models are not free from defects and cannot be implement perfectly.
y The application of the CIA merely depends on the risk of certainty where as

flexibility is the financial options which are many.
y The misapplication is the dysfunctional decision making from the management

by manipulating CIA application inflexibly for uncertainty. The researcher¶s synthesis of the research question in the highly sensitive part of CIA issues pertaining to misapplication and mismanagement for England has been done by the best analytical ability of critical and logical examination. These are 46


the general findings of CIA discrepancy, uncertainty, and inconsistency for organization in England. The analysis of this part is more crucial, complex and intensely complicated for analytical finding of the exact reasons of misapplication and mismanagement. The researcher analytical findings are in the form of point given below for further detail discussion.

Analytical Finding of CIA Discrepancy, Uncertainty, and Inconsistency CIA Discrepancy:
y The cash flow which is the centre of gravity in capital investment forecasting

play an important role in discrepancy by futuristic DCF.
y Overstated discount rates is the dysfunction approach of investment report

presenter which threats a serious risk to CIA by misapplying DF.
y Unpredictable rate of inflation may also affect the accuracy of CIA through the

above two individual factors those are simultaneously link to rate of inflation.
y The erroneously treated government taxation and neglecting personal tax

payable is the problem of discrepancy for post tax cash flows. Unfortunately there is no valid model for this type of discrepancy. CIA Uncertainty:
y The profit of uncertainty indirectly effecting working capital. Though working

capital has to be reasonable low for newly entrant in the market. A low profitable firm would have high cost for working capital.
y It is likely that imperfect capital market would lead to miscalculation on interest

rates that would also unrealistically calculate the ROI.
y Hypothesis testing proved that a LL firm can become a RBP firm after a

transitory period. Provided the firm should operate at right level of gearing and without dysfunction decision making for investment.
y Rate of inflation has the implication for adjusting the rate of nominal and rate of

real inflation which is addition to the uncertainty of inflation.
y The VaR mathematical calculates the maximum loss in the project. VaR

categorized as another analytical utility for CIA such as breakeven point, margin of safety and market security line.



y Corporate merger and acquisition are not recommended on basis of synergy or

technical feasibility of project. An attractive joint venture most likely end up in disaster as precedented is case studies.
y Indifference investment decision making is not the core issue for CIA. Single

project can use basic criterion and mutually exclusive projects should adopt professional CIA techniques.

CIA Inconsistency:
y The inconsistency has been found throughout all CIA techniques because it has

been made inconsistent by the resident uncertainty in the basic theory of PP.
y The modification of PP method was applied with discount rate. y The modified forms of PP method are WACC and DCF. These CIA methods are

driven by investment forecasting and discount rate.
y DCF method is complicated method and largely acceptable. It is encouraging to

see that most of the English firm use NPV method of DCF.
y The ARR and IRR have ambiguous assumption for percentage comparison with

ROCE/ROI. The absence of authentic method for ROCE/ROI and the percentage figure are the problems for executives to analyse the applied rate of return.
y Profitability index and benefit/cost analysis are the progression of DCF for the

quick screening the mutually exclusive projects.

4.1.2 Misapplication and Mismanagement (M&M): The CIA under uncertainty had been reported as the case of misapplication and mismanagement. There were many case studies that had been quoted as an incident of M&M. The dissatisfaction as outcome of M&M is by the adverse effect of individual or joint options of CIA applications. The misapplied application options results in totality of CIA mismanagement. The researcher had discussed all these factors of application options in depth and detail to evaluate performance of CIA for private companies in England. The most prominent group factor for M&M is uncertainty which is the reason for other two basic group factor of flaws in the CIA that is discrepancy and inconsistency. Researcher had justified his argument of CIA practical incapability under uncertainty. Researcher must break the entire



literature review for studying the misapplication and mismanagement separately in this analytical discussion.

Misapplication of CIA: There is no perfect method, model, or technique which can be regarded as a complete and defect less investment forecasting tool. That is why there is no perfect rules for CIA application for inconsistency. The main problem is the element of uncertainty which is the permanent resident in CIA for misapplication of flexible financial options. By saying there are not perfect rules the researcher have point out the direct criticism on the inconsistency of decision criterion in CIA. The ground of inconsistency is evident from the gap in the basic theories of PP method. The first technique was inconsistent by arbitrated cash flow assumption so the decision criterion begun to shape up inconsistent throughout the entire process of modification. The objective of this researcher is achieved with the proven inconsistency among the modified methods presently in practise such as WACC, ARR, DCF (NPV & IRR), BCA, and PI. Therefore the modification of CIA application and contemplation of advance models is in still progress to date. The researcher argument for misapplication can be supported without any hypothetical example. International Iron and Steel Institute (1983) the DCF is more accurate measure than ARR and PP according to author preference. NPV and IRR can measure the amount of money earned in one year with the worth of money next year. The ARR and PP has been charecterized as short cut and suplementory tools. ³One widely known source (A.J. Merrett and Allen Sykes) states that the used of payback period ³result in blind conservatism´ where other refer ti it as being charateristic of a dynamic investment policy.´ (International Iron and Steel Institute 1983:1-5) the corporate auther futher prefer NPV over IRR to avoid the difficulty of IRR misleading calculation. IRR may select the low investment project over a high investment project which is more attractive for ROI. Researcher has refered (Dayananda 2002) that however the problem of IRR interpolation calculation can be solve with computer software. This elicit the entire issue of CIA misapplication by inconsistant methods.



Misapplication by DCF Implication: The term discounted cash flow has joined by two fundamental mechanics of investment forecasting technique. These are cash flow (forecasted) and discount rate (applied). Therefore the two basic and uncertain aspects of CIA have been chosen for the misapplication analysis. The synthesis of DCF has told that it is not the entire method of CIA on its own. It is the procedure to convert the forecasted cast flow into time value of money. The uncertainty of cash flows alone has great effect on the investment forecasting. While combining with the discount rate set by imperfect capital market it even become further uncertain and bias technique. The executive are familiarity to PP method by executives is evident from the large acceptance of NPV by English companies. It is easy to accept NPV over IRR because NPV assert the stated figure in term of monetary amount rather than an ambiguous percentage of IRR. Executive need more information for the interpretation of DCF result. On this merit researcher agreed to Ezra Solomons cited in Lucey (1971) that a NPV is more adaptable technique as compare to IRR because it is not only easy to calculate but also to follow its meaning and interpretation with a calculated value. Contrary to the statement that, ³Many (including accountants) find it easier to understand an IRR result (a percentage) rather than an NPV result (a discount value) and in many cases both methods of appraisal are adequate as an aid in decision-making´. (West and Stein 1997:27) writer¶s opinion favour the interpretation yield result in percentage because it is easier to demonstrate profitability in percentage rather than in form of numeric value. The management accountants prefer percentage result of IRR. The other reason why IRR is famous and adaptable in some organization because it is more accurate then NPV for the project which explicit to further investments because it is more appropriate for investment forecasting without ambiguity for additional investment. However research has the statement that, ³There are a number of reservation applicable to IRR methods which should be understood.´ (West and Stein 1997:27) the same effect to this statement also given by Hawkin & Pearce (1971), Atrill & McLaney (2005) and Dixon (1994). The two techniques of DCF contradict each other where the evolved conflicts for mutually exclusive projects were under consideration for inconsistency of CIA decision criterion. The problem of DCF conflicting error can



be simplified by the rule of selecting the project with higher of larger positive NPV.

Mismanagement of CIA: Mismanagement of CIA is not as gray area as other financial planning and decision related issues of misapplication are. The decision making techniques of CIA are very common in any large scale business of England. The management would be helpless to make any decision for the problem originated by uncertainty. If there are no flexible options available for financial decision making. There have been some critical findings of discrepancies in flexible decision making on the part of management by practicing CIA misapplication. The practical example of mismanagement is given by Hirst (2001) that there is a minconsecption about physical assets and project life. ³An asset lasts until it rusts, corrodes, becomes unreliable or obsolete. A project is an economic opportunity that lasts until the business environment changes.´ (Hirst 2001:4) mismanagement often occurs when management does not attend the related issues of discrepancy and uncertainty such as;  Analysis of risk uncertainty.  Flexibility in decision making with cost of capital under real and financial investment options.  Working capital, taxation, inflation, application of discount rate, investment time horizon and  Merger & acquisition. The management has to prove its ability by using the variety of flexible options effectively. Management only fails in their objective when the decision making is not flexible with all available financial options. The rule of thumb had never been applied in CIA and it could never be applied for financial and economical challenges.

No Perfect Rules for Management: It had been found by the researcher after consulting the critical literature review that the rules of CIA applications are inconsistent for decision criterion. Ranking a project for investment is not indifference by available techniques of CIA which could be use for screening



process. The issue of inconsistency remain with the technique of CIA used for selecting the project. Researcher had examined gaps related to CIA¶s theories, models of financial option as well as factors of financial option effected by inconsistencies. The very important objective regarding inconsistency is decision criterion. The inconsistencies in the decision criterion is normal for the complexity of the objective. The objective of CIA is to realistically forecast the future outcome of the capital investment in recent time. The future scenarios would always change due to scare resources and other factor of capital investment. The financial authorities for decision making are abreast to adjust the CIA techniques or to evolve advance models time to time. That is how CIA have different methods of theories and advance models. The methods serving their purpose to be in practice so the idea of researcher is assertive that there is no hard and fast rule in CIA. Therefore it is justified from above argument that there is no perfect rule in CIA for project decision criterion.

The above discussion had been done in the reference of misapplication and mismanagement. The researcher has analytically found the gaps and flaws in CIA¶s theories, models, and application of financial option for the 1st objective of study stated below as; 1st Objective: To analyse different theories, models, and applications of capital investment appraisals (CIA) of private sector for businesses in England. 2nd Objective: To critically evaluate the complex performance of capital investment appraisals (CIA) in large scale private sector enterprises in England. 3rd Objective: To elicits views and perspectives of investment institutions about capital investment appraisal (CIA) for England industry to expose possible discrepancies, uncertainties, and inconsistencies.



The 2nd and 3rd objectives has been coherently done in cohesive manner for the integrated and complex performance of CIA by the group factors of discrepancy, uncertainty, and inconsistency. The performance of CIA which was critically reviewed in literature for the group factors of discrepancy, uncertainty and inconsistancy has been analysed in the discussion for implication of misapplication and mismanagement of flexible options. The two objectives were discussed under misapplication and mismanagement results from discrepancy and inconsistency which were duly caused by the uncertainty. 4th Objective: To recommend suggestions how to capital investment appraisals (CIA) may be improve to meet the aims of a more adaptable and applicable financial decision making process for private investors sector in England.

The fourth and final objective has not yet been taken the discussion attention for recommendation and suggestion from analytical finding in literature review. The researcher would make his recommendation and suggestion on the ground of research findings after given his last words on conclusion for CIA M&M. The dilemma discussed for M&M concludes that the mismanagement is totally controllable unlike the misapplication. The CIA applications made flexible with build-in inconsistency for catering risk of uncertainty. The entire blame cannot be laid on the misapplication by inconsistent model of CIA and mismanagement for discrepancy. The discrepancy in DCF is the dysfunctional strategy for catching up the targeted interest rate on investment. This is misleading by capital market to limit the CIA performance for benefiting companies in England by realistic ROI. The practice of CIA in many organizations is serving in the wishes cycle of financial requirements. The interest rate in the capital market is always higher than the expected or achieved economic growth rate. Principally prepared CIA is not a practical tool for projects evaluation on ROI. The higher return in capital market has been in practise for more than a decade to attract investment in the financial market. There is less hope for investment in development especially forms privately funded projects. When investors initiate effort with CIA¶s technique to achieve the challenging interest rate set by imperfect capital market.



Management faces enormous difficulty to achieve practically what is predicted in the project¶s by mean of a bias, unrealistic or misapplied and mismanaged CIA report. The management for decision making had only deceived the top hierarchy for gaining financial resources either from intern resources or externally by borrowing from investment banks.


RECOMMENDATIONS: There are recommendations for CIA methods

and application of financial options. These have been discussed for M&M according to their merit of performance. The recommendations for methods are given for avoiding misapplication. The recommendation for application of flexible financial option would help to avoid recommendation for methods; mismanagement followed after

Recommendations to Avoid CIA Misapplication Payback Period: The PP method has high level of inconsistency by arbitration of investment horizon and cash flow forecasting which is not discounted. So it is better to avoid this technique for investment forecasting, however it has good assumption of breakeven analysis for diversified investment. Accounting Rate of Return: ARR bears the maximum inconsistency in selecting and ranking a project for capital investment. It is highly recommended not to use ARR unless the management has fully confident by analysing ARR technique for mutually exclusive projects. It has all short coming that PP has plus it own flaw of comparing with unauthentic ROCE and interdependence on average investment. Weighted Average Cost of Capital: The WACC can only be suitable for the project which has limited investment that cannot alter the capital structure of company. The other assumption indicates that risk position in the company should not be increase by investing in the project. This assumption limit the use of WACC in project of diversification where it should be avoided from misapplication in risk evasiveness.



Discounted Cash Flow: The discounted cash flow is more stable and less inconsistent method of CIA among its family members. In choosing which particular technique of DCF to be applied between NPV and IRR management has to seek for right decision criterion. NPV is commonly accepted in England which does make IRR an inferior method. The conflict should be made for the base of selection. If there is no conflict in DCF than NPV should be use for project presentation. IRR should be used there as basic CIA technique because IRR is more consistent technique than NPV for investment forecasting.

Recommendations to Avoid CIA Mismanagement Analysing Risk of uncertainty: The Risk of uncertainty can be reduced to mimimum level if the management made aware of risk evaluating techniques such as VaR, MOS, SML and BE point analysis.

Flexible Decision Making: The entire process of CIA has been aimed for final decision of accepting or rejecting a project. Gaps in the financial options and major flaws of inconsistency in the theories and models of financial application can enforce inflexible decision that would endanger the investment and forgo the financial flexibility of CIA. For example BCA and PI are the techniques of flexible decision making. These also serve as screening tool for investment when the firm have budget constrain. BCA and PI would be mismanaged by NPV misapplication. It has been made available by many authors that the financial or real investment options has interrelationship. Even though the real options are not as flexible as financial options since they are interrelated to form a coherent strategy that can be used for CIA. The financial options have flexibility and adaptability to the investment circumstances oppose to the rigidity of real options due to their capital market valuation. The strength of cost of capital gives flexibility to the financial option therefore cost of capital play a vital role in deciding any investment decision. For instance the financial flexibility of WACC and ARR can be find out from cost of capital. Some firm may find capital investment easy to adjust due to their low gearing and variety of capital assets in possession. In case of low leverage firms it is recommended to use the flexibility



of financial option and operate on low profitability. It is suggested to avoid dysfunctional decision making and remain LL firm for two to three years of transition till it becomes RBP firm against its capital resources.

Working Capital: The option of working capital in uncertainty is flexible for maintaining it in the business operation. The firm of low profitability for limited turnover in the market can keep the low leverage option by minimum requirement of working capital. It is obvious that capital tie up in form of working capital have low solvency and liquidity problems.

Taxation: Taxation is also a flexible financial option which may turn up as factor of discrepancy caused by mismanagement of taxation. The discrepancy has originated from the lack of treatment for personal tax. The result would be in post tax cash flow without calculation of personal tax. Therefore management must make sure the fair treatment to all futuristic tax payable in DCF.

Inflation: It is emphasized and now recommended that the issue of inflation should be address seriously. Inflation can be more implicative in discrepancy for cash flow forecasting and applied discount rate. The misapplication of inflation rate without adjustment of nominal and real rate could double the risk of uncertainty so an adjusted rate of inflation should be applied. The management will find later that the reason of discrepancy in predicted cash flows was the misapplication of inflation rate fluctuated by imperfect capital market which has point out earlier in misapplication by DCF implication. Application of Discount Rate: The discount rate is use for cash flow first presented for PP method. The cash flow is the middle pillar of any investment and a project is dependent on the forecasted cash flows. The static cash flow change into DCF with the integration of discount rate. Misapplication of discount rate can severely put the capital investment at risk either by imperfection of capital market or by deliberate overstating. An imperfect capital market is out of bond to be control and rarely predicts with certainty. This is the critical point for decision



maker to assess the investment on its merit and avoid any manipulation without dysfunctional making decision. The management skill of contingent investment planning is the solution. The inconsistency of CIA has brought forward the foresighted planning for contingent investment. The discount rate not only related to NPV and IRR it is also applicable for WACC, BCA and PI. The NPV is an extension of PP methods with discount rate so it highly recommended as it is practice by mostly companies in England.

Finite Investment Horizon: This is a simple concept for investment time frame objectivity which written by Lucey (1971). Investment time horizon is strongly suggested for restricting the risk evolution and counter uncertainty. It has also suggested that the projects with specific investment time horizon would have minimum risk of certainty. Projects of longer or no investment time horizon would be more risky and expose to uncertainty. Lucey (1971) another disadvantage of infinite time horizon for investment planning result in a higher level of risk involve for longer period of uncertainty. A specified investment time horizon period should have some fix years in number e.g. 5,10,15 or even 20. Investment time horizon stops the dilemma of unforeseen forecasting error as well as provides certainty of benefits within the targeted investment time of the project. The forecasting error is unavoidable so the decision maker should have clear understanding for margin of error in forecasting to provide a contingency plan for financial investment in of emerging financial crises.

Merger, Acquisition and Joint Venture: Merger and acquisition had been reported with case study of failures where management had bear burden of unsuccessful joint venture or absorbing an entity. Mismanaged decision made for merger, acquisition and joint venture result from unplanned, poorly planned, biased, and ambitious investment forecasting. It is not recommended to undergo an investment which is enticed on assumption of lucrative return. Acquisitions also not supported for increasing technical expertise in the business. Management should not decide any joint venture on foreground of feasibility. Merger, acquisition, and joint venture are big, risky and irreversible decisions.



4.2.1 Suggestions: The suggestion to utilize the CIA process for private enterprises in England. 1. Find out the reality behind capital investment because an appropriate CIA technique for investment would always minimise risk factors. For example is it the investment for expansion, diversification, or modification. 2. Go beyond the generalization concept of CIA and test it for the particular business proposal. 3. A CIA should be applicable and serve its purpose through an unbiased input. That would give a prudential and realistic investment report which should has positive characteristics so no blame can be laid on CIA. 4. CIA must be an independent report by the top management who decide to invest in the project. There should not be any other dysfunctional financial factors that may invalidate CIA. 5. Instead of misapplying CIA technique for project approval a correct decision should be taken by investing in a project of low gain which may not be attractive for investment. 6. A low economical return project would not always be endanger to fail but a project mislead by CIA would always have element of much higher uncertainty for failure.



t ti ± S ti 5 REFLEC REPOR


LE y a t pic as researcher for writing a MBA

Thi i my fi t experience t st

dissertation. The entire process of C A dissertation has been stretched over a period of up to 8 months. The Kolb cyc 1984 can be related to present my le learning cycle. The learning cycle is reflected in process of ³Research Skill Analysis´ (MBA Top Up) that I have highlighted as important self learning experience.

FIGURE 2: Kolb. D.A. (1984) Model of Experiential Learning Cycle

(Source: Kolb Learning Cycle Tutorial - Static Version)



methodology for dissertation was not very wide or complicated. This is where my-self learning took place being a researcher in MBA course. The whole experience of self learning moved around the research methodology for reflective learning. 
©§ §




lan: The confusing experiences of switching the research

methodology made me realise that I must stick to the decided plan. It was learned that in the future I should give full concentration to the delegated tasks so the plan could work favourably. Patience and persistence makes the plan workable before


¥¤ ¦¡

¥¤ £ ¢ ¡    




any mile stone would be reach in the set objective. There is no harm to try and test new ideas but the confidence is the basic requirement for plan implementation. I submit myself to the research methodology learning had taught me being a researcher. To reflect my learning outcome from this I would have to finalize it for submission.

Do Whatever It Takes: This is the situation which referring how I got over the problems in completing my dissertation. I had to correct the plan for dissertation and taking every task seriously that may obstruct my dissertation. The advice was also suggested from my well wisher to pay full attention to the studies and get it done as soon as I can. I rectified research methodological and also took some bold steps. I relocate myself from where it would be easy to access the resources for research. I lost my part time job in the middle of my dissertation to which I was not worried in early days, but later the money mattered. Friendly advices came to me that I should not be worried for a job and concentrate on my academic scope. I was motivated and determinant to finish my dissertation by doing whatever it takes.

Flaw in Methodology: The very first stage of my self-learning comes after the very first meeting with my supervisor Dr. Mike Doyle. In that meeting the serious issue of research methodology for selected topic had emerged. I had been guided by my supervisor that although I will not be able to gain the desired access in financial institution for the collection of primary research data. Instead I can cover up the lacking of data for analysis with the extensive and elaborated literature reviews.






disappointing to navigate the research methodology from primary research to desk based work in the earlier stages of my dissertation. This issue occupy my thought and believe to such an extent that the capabilities to justify my research were affected. At that point I had not completed the third chapter of literature review. The feedback was not encouraging because I had sent it for reviewing in






incomplete form to Dr. Mike who comment that, it is not worthy of passing the dissertation.

Initiating Right Methodology: The corrected research methodology in the form extended literature review had been initiated. I felt that there is still lacking for ethical issue such as primary and secondary data collection. I was over confident that at that stage of my dissertation I should make some changes for primary research data. Being a researcher I had not supposed to be sceptical about my selected stored data. Readers would notice that I have put an incredible effort to prepare a large selection of online data. The research strategy for basic literature collection scheme had all kind of required literature for reviewing. The big challenge was how to start by selecting a particular part of extended literature review. There was another difficulty for understanding the entire literature because the selected study of CIA was a broad topic. The important task was focusing the topic critically after preparation of good database to comprehend the study.






dissertation proposal I have taken a learning style questionnaire which was source designed Dr. Kelly (2009). The questionnaire had 80 question altogether to understand the learning style preference of a person in respect of Activist, Reflector, Theorist and Pragmatist. The score I had was 8, 17, 15, and 18 respectively for learning style trait. The LSQ suggest that I have very strong preference for pragmatic approach. I also prefer strongly the style of theorist or reflector whereas moderate on activist learning style. The point was made for identifying the futuristic reflection from entire self experience by adopted learning style preferences. The application of self learning would be very strongly as pragmatic, strongly as theoretic, or reflective and moderate as an activist. Patience and Persistence: The conclusion for self learning application is the patience and persistence. I would be practical and confidently with the predesigned plan by using time tracking for consistent progress. I would avoid any issue that may drag my attention and cause unjust delay to my plan without 61  


During the


reasonable cause. I would not let severe lacking of interest or devotion to hamper my plan. A firm believe in the plan would be observed in the form of theoretical case study for preservation from unforeseen jeopardy in delegated task. I would be moderate as an activist into my future plan of job career because I had been wrong for being a highly activist while I could be moderate in doing my dissertation. It shows that the learning style may not support me on activist work planning. Therefore for me suitability is the modestly active for upcoming future works and pre plan tasks.


Dissertation - Appendices

APPENDICES Chapter 2 - METHODOLOGY APPENDIX A 1. Research Resources: Consistently and persistently daily visit to London¶ largest British library have been very helpful in searching online data from its reading room of Business and Intellectual Property Centre (BIPC). Apparently there was no initial difficulty but delay to look for CIA related literature sources but all were found to be critical and relevant or to be precise well relevant. All of these resources were saved on the British library beta website under different categories of folders for tracking and bibliographic citation. Researcher has done same for the collection of book references for research philosophy and methodology that he has been quoting in chapter 2 of methodology.

Chapter 3 - LITERATURE REVIEW APPENDIX B TABLE 7: Abbreviations List in CIA ARR BCA BE CIA DCF DF FV NFV NPV LL Accounting Rate of Return Benefit and Cost Ratio Break Even PI PP PV Profitability Index Payback Period Present value Return on Capital Employed Resource Borrower Power Return on Investment Rate of Return Security Markey Line Weighted Average Cost of Capital

CapitalInvestment Appraisal ROCE Discounted Cash Flow Discount Factor Future Value Net Future Value Net Present Value Low Leverage RBP ROI ROR SML WACC

APPENDIX C 1 Present Value Table: This is a discount factor table or future value table . So these could be calculated for representing the multiplicative of (1 + r) 63

Dissertation - Appendices

different interest rates or discount rate and number of period or years. It is also available in a tabulation form for various interest rates and number of years or periods. 2 Annuity & Present Annuity Table: It is the quickest way to find out

present value of money. If the cash flow amount is constant over a definite period of time than time value of money either PV or FV can be calculated with the help of annuity table. The annuity table is the calculation of annuity factor in tabulation presentation of discount rate to the corresponding number of periods of years. The table can be calculated from following mathematical factor for present and future annuities. Formula 12: Present Value Annuity Factor 1 - (1 + r) r
(Source: CECOS NQF level 7)

TABLE 8: Illustration of Annuities Annuity CF (10%) 3.791 5,000 YEAR 1 2 3 4 5 TOTAL CASH FLOWS 5,000 5,000 5,000 5,000 5,000 25,000

Net Present Value (PV) 18,955 DISCOUNT FACTOR (10%) 0.909 0.826 0.751 0.683 0.621 3.790 PRESENT VALUE (PV) 4,545 4,130 3,755 3,415 3,105 18,950

(Source: CECOS NQF level 7)

Note: rounding fraction of discount factor give a discrepancy of 5 in NPV. 3 Perpetuities: If the cash flow is same over an indefinite or unforeseen

period of time then it is said to be a perpetual cash flow or perpetuities.


Dissertation - Appendices

Formula 13: Present Value of Perpetuity PV of Perpetuity Po = Fixed Annual Cash Flow r
(Source: CECOS NQF level 7)

APPENDIX D 1. Probabilistic Treatment of Uncertainty: Lucey (1971) explain how the

probability of residual cash flow calculated as well as how a detailed forecast probability of residual net cash flow can be estimated. This is very target probabilistic approach to find out future cash flow. a) Residual net cash flow ± only take the measure of central tendency mean

of the all future cash flows and it would give the half probability of what could be the residual net cash flow b) Detailed forecasts for residual net cash flow ± other factor of sales such as

market size, price of product, product share of market etc. This is also a practical estimation taken present and future factor into consideration for evaluating future residual net cash flow against present investment.

2. a)

Simulation Process for Uncertainty: Sensitivity Analysis ± Changing all effecting factor to either direction

would give an idea of stimulation. CIA decision can be taken with these variable factors to control or alter them for required investment appraisal. b) Monte Carlo Simulation ± A vary detailed calculation required to handle

all possible simulation by calculating various combination such selling price and sales volume estimation or any other critical estimation that may be probable to investment.


Dissertation ± Bibliography

BIBLIOGRAPHY 1. Anonymous. Capital Investment-A New Approach. Management Accounting. 1998. p. 28. 2. Anonymous. The Post Office's Capital Programme. The Post Office. 1983. 3. Atrill. P & McLaney.E. J. (2005) Management Accounting For Decision, 4th Edition. Harlow, Financial Times Prentice Hall. 4. Azzopardi. F. A Holistic View On Investmen Appraisal. University of Leicester. 2004. 5. Baddeley. M. C. (2006) Behind The Black Box: A Survey Of Real-World Investment Appraisal Approaches. Empirica, Vol. 33. No 5 pp329-350. 6. Bell. J. (2005) Doing Your Research Project : A Guide For First-Time Researchers In Education, Health And ocial cience, 4th Edition. Maidenhead, Open University Press. 7. Bergmann. B. R. (2009) The Economy and the Economics Profession: Both Need Work. Eastern Economic Journal, Vol. 35. No 1.pp 2-9. 8. Berry R. H. & Dyson. R. G. (1979) A Mathematical Programming Approach to Taxation Induced Interdependencies in Investment Appraisal. Journal of Business Finance & Accounting, Vol. 6. No 4. pp425-441. 9. Buckle. D. J. (2005) Ex post Reality Versus Ex Ante Theory of the Fundamental Law of Active, Journal of Asset Management, Vol. 6, No 1. pp 21-32. 10. Bullock J. and Jones. P. F. Capital Investment Appraisal. British Productivity Council. ?. 11. Busby. J. S & Pitts. C. G. C. (1998) Assessing Flexibility in Capital Investment. London, CIMA publishing. 12. Centre for Financial and Management Studies University of London. Investment and Project Appraisal. University of London. 200?. 13. Das. R. K. (1974) Optimal Investment Planning : A Reappraisal Of Mahalonobis-Fel¶dman trategy. Rotterdam, Rotterdam University Press. 14. Datamonitor. Credit Suisse Case Study: Improving Efficiencies In Wealth Management Through IT Investment. Datamonitor Plc. 2005. 15. Datamonitor. Merrill Lynch Case Study. Datamonitor Plc. 2005. 


Dissertation ± Bibliography

16. Davis. A. (2006) The Limits of Metrological Performativity: Valuing Equities in the London Stock Exchange. Competition & ChangeU, Vol. 10. No 1.pp321. 17. Dixon. R. (1994) Investment Appraisal: A Guide For Managers. Revise Edition. London, Kogan Page, Co-Published With The Chartered Institute Of Management Accountants. 18. Dayananda. D., Harrison. S., Herbohn. J., Irons. R. & Rowland. P. (2002) Capital Budgeting : Financial Appraisal Of Investment Projects . Cambridge, Cambridge University Press. 19. Dr. Kelly. P. (2009) Learning Style Questionaire. LJMU international Management Course. 2009. 20. Drury. C & Tayles. M. The Misapplication of Capital Investment Appraisal Techniques: Management Decision. Huddersfield MCB UP Ltd. University of Huddersfield. 21. Erdal. B. (1997) The Effects Of Real Exchange Rate Volatility On ectoral Investment : Empirical Evidence From Fixed And Flexible Exchange Rate 

ystems. New York, London, Garland.

22. Fairplace Institute of Banking & Finance. Financial Times Management. & Gardner. D. C. (Ed.). (1998b) Black- choles Option Pricing Model. London : Financial Times Pitman Publishing. 23. Fairplace Institute of Banking & Finance. (1998d) Regulatory Issues For Investment And Fund Management. London, FT Pitman Publishing 24. Fairplace Institute of Banking & Finance. & Gardner. D. C. (Ed.). (1998a) Capital Investment Appraisal. London, Financial Times Pitman Publishing. 25. Farrar. D. E. (1967) The Investment Decision Under Uncertainty. Chicago, Markham Pub. Co. 26. Fisher. C. M. (2007) Researching And Writing A Dissertation : A Guidebook For Business tudent, 2nd Edition. Harlow, Financial Times Prentice Hall. 27. Fisher. K. Nine Ways to Avoid Investment Mistakes. Fisher investment Europe Limited. 2010. 28. Foundations of Qualitative Research. Postpositivist And Critical Perspectives. Foundations of Qualitative Research. 1st February 2007.


Dissertation ± Bibliography

29. Gardner. D.C. & Fairplace Institute of Banking & Finance. (1998c) Capital tructure. London, Financial Times Pitman Publishing. 30. Gardner. D. C. & Fairplace Institute of Banking & Finance. (1997a) Risk Analysis For Capital Markets. London, FT Pitman Publishing. 31. Gardner. D. C. &Fairplace Institute of Banking & Finance. (1997b) Risk Analysis For Portfolio Investments. London, Financial Times Pitman Publishing. 32. Gill. J. & Johnson. P. (1997) Research Methods For Managers, 2nd Edition. London : Paul Chapman. 33. Götze. U., Northcott. D. & Schuster. Peter. (2008c) Investment Appraisal : Methods And Models. Berlin, Springer. 34. Grundy. A. N. Managers' Perspectives on The Linkages of Strategic and Financial Appraisal of Major Investment Decisions. Cranfield. Cranfield Institute of Technology School Of Management, June 1992. 35. Harrison. I. W. (1973) Capital Investment Appraisal. London, New York, McGraw-Hill. 36. Hawkins. C. J & Pearce. D. W. (1971) Capital Investment Appraisal. London, Macmillan. 37. Helliwel. J. F. (Ed.). (1976) Aggregate Investment : elected Readings . Harmondsworth, Penguin Education. 38. Hintze. J. Bullish: BofA Integrates Merrill Lynch's Herd. Securities Industry News. 2009. P. 19. 39. Hirst. I. R. C. (2001) Investment appraisal for shareholder value. London, Financial Times/Prentice Hall. 40. Holmes. P. (1998) Investment Appraisal. London, International Thomson Business. 41. Institute of Cost and Management Accountants New Zealand Centre. & Putterill. M.S. (Ed.). Seminar Papers: Major Project Investment Appraisal. ICMA New Zealand. Mar 1981. 42. International Iron and Steel Institute. Committee on Economic Studies (Brussels). (1983) Investment appraisal in the steel industry. Brussels,
# "

International Iron and Steel Institute.


Dissertation ± Bibliography

43. orion. P. (2001c) Value at risk : The New Benchmark For Managing Financial Risk. 2nd Edition. New York City, London, McGraw-Hill. 44. Kane. E. (1983) Doing Your Own Research : Basic Descriptive Research In The ocial ciences And Humanities. Dublin, London, Boyars. 45. Kon. Y. Capital Input Choice Under Uncertainty: A Putty-Clay Technology Case Osaka University. Suita Institute of Social and Economic Research. 1980. 46. Llewellyn. D. T. (2005) Competition And Profitability In European Banking: Why Are British Banks So Profitable?, Economic Notes Nov2005, Vol. 34. No 3. pp279-311. 47. Lucey. T. (1971) Investment Appraisal: Evaluating Risk and Uncertainty. London, The Institute of Cost and Work Accountants. 48. Lumby. S & Chris. J. (2001c) Fundamentals Of Investment Appraisal. London, Thomson Learning. 49. Lumby. S & Chris. J. (1999) Investment Appraisal And Financial Decision, 6th Edition. London, International Thomson Business. 50. Lumby. S & Chris. J. (2003) Corporate Finance : Theory & Practice, 7th Edition. London, Thomson. 51. Magdy. G. A. K & Dugdale. D. Evaluating Investment In Advance Manufacturing Technology: A Fuzzy Set Theory Approach. Colchester university of Essex, 2001. 52. Marchica. M & Mura. R. (2006) Financial Flexibility And Investment Decisions :Evidence From Low-Leverage Firms. Mancheste, Manchester Business School. 53. May. A. D., Bristow. A. L., Fowkes. A. S., Hopkinson. P. G., Mackie. P. J., Nash. C. A., Bates. J., Roberts. M., Winn. R. The Development Of A Common Investment Appraisal For Urban Transport Project. The University of Leeds. Dec 1991. 54. Moran. K. (2000) Investment Appraisal For Non-Financial Managers : A tep-By- tep Guide To Making Profitable Decisions. London, Prentice-Hall.
% % $ $

55. Mott. G. (1987c) Investment Appraisal For Managers : A Guide To Profit Plannin. 2nd Edition. Aldershot, Gower.


Dissertation ± Bibliography

56. National Economic Development Council. (1969) Investment appraisal. 3rd Edition. London. London. 57. Noor. K. B. M. (2008) Case Study: A Strategic Research Methodology. American Journal of Applied Sciences, pp. 1602-1604. 58. Roberts. C. M. (2004) The Dissertation Journey : A Practical And Comprehensive Guide To Planning, Writing, And Defending Your Dissertation. London, Corwin, Thousand Oaks (Calif.). 59. Robichek. A. A. & Myers. S. C. (1965) Optimal Financing Decisions.. Englewood Cliffs, Prentice-Hall. 60. Saunders. M, Lewis. P & Thornhill. A. (2007) Research Methods for Business tudent,. 4th Edition. Harlow, Pearson Education Limited. 61. Segelod. E. (1991) Capital Investment: Towards A Contingency Theory. Sweden, Lund, Chartwell-Bratt. 62. Strong. N. C. & Appleyard. T. R. (1992) Investment Appraisal, Taxes and the Security Market LINE, Journal of Business Finance & Accounting, Vol. 19. No 1. pp 1-24. 63. Taziralis. G., Kirytopoulos. K., Rentizelas. A. & Ilias. T., (2009) Holistic Investment Assessment: Optimization, Risk Appraisal And Decision Making. Managerial & Decision Economics, Vol. 30. No 6. pp393-403. 64. Smit. H. T.J, & Trigeorgis. L. (1995) Flexibility And Commitment In
( ' &

trategic Investment. Rotterdam, Tinbergen Institute.

65. Tanega. J, Sharma. P. & Gardner. D.C.(Ed.) (1997) Case tudies For Corporate Treasury. London, FT Pitman Publishing. 66. West. C. & Stein. N. (1997) Investment Appraisal. London, CIMA Publishing. 67. Westwick. C. A. & Shohet. P. S. D. (1976) Investment Appraisal And Inflation : Report. London, Institute of Chartered Accountants in England and Wales. 68. White. B. (2002) Writing Your MBA Dissertation. London, Continuum.


Dissertation ± Bibliography

Web Sites 1. British Library Beta Search. (Last modified 31th January 2011). <http://searchbeta.bl.uk/primo_library/libweb/action/search> 31th January 2011). 2. British Library Business Resouce. (Last modified 31th January 2011). <http://www.bl.uk/eresources/business/cd-busin.html> January 2011). 3. Business and Inteclectual Property Center. (Last modified 31th January 2011). <http://www.bl.uk/bipc/index.html> (Accessed On 31th January 2011). 4. Kolb. D.A. Model (1984). Kolb Learning Cycle Tutorial - Static Version. (Last modified 13th December 2010). <http://www.ldu.leeds.ac.uk/ldu/sddu_multimedia/kolb/static_version.php> (Accessed On 17th January 2011). 5. Lobato. D (2008). Chapter 3. Post-Positivist Perspectives on Theory Development. (Last modified 28th November 2008). <http://davidlobato.wordpress.com/2008/09/14/chapter-3-post-positivistperspectives-on-theory-development/> (Accessed On 17th December 2010). 6. Trochim. W. M. K (2006). Positivism & Post-Positivism. (Last modified 20th October 2006). <http://www.socialresearchmethods.net/kb/positvsm.php> (Accessed On 17th December 2010). (Accessed On 31th (Accessed On