Briefing

Capital investment decision-making:

some results from studying entrepreneurial businesses
Francis Chittenden and Mohsen Derregia
Manchester Business School, University of Manchester
Chartered Accountants Hall PO Box 433 Moorgate Place London EC2P 2BJ
Tel 020 7920 8100 Fax 020 7638 6009 www.icaew.co.uk
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Briefing
Capital investment decision-making:
some results from studying entrepreneurial businesses
Francis Chittenden and Mohsen Derregia
Manchester Business School, University of Manchester
b
b
Centre for
Business
Performance
Thought
leadership
fromthe
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1
Introduction
This Briefing presents the results from a two-year study
of the relevance of Real Options
1
to capital investment
decision-making in small, medium, and large firms. In
addition, we have sought to discover whether there are
differences between the capital budgeting practices adopted
by entrepreneurial firms and average performing businesses.
The study confirms that many firms use the payback (PB) method of
investment appraisal in addition to discounted cash flow (DCF) models.
This is a well known observation that has been attributed to the
apparent lack of sophistication of practising managers, amongst other
things. However, by exploring the nature of business risk we conclude
that the use of payback is consistent with Real Options models of
investment decision-making. The increasing levels of risk and uncertainty
faced by businesses lead to a preference for rapid recovery of the funds
invested, and demand for flexibility. However, this does not mean that
discounted cash-flow models are no longer relevant. Many sophisticated
companies use PB, internal rate of return (IRR) and net present values
(NPV) as well as thinking about investment projects in ways that are
consistent with real options concepts. They perceive the use of multiple
techniques as different ways of looking at an investment.
Recently some firms began to offer various types of fixed assets through
operating leases and rental or hire contracts, thereby creating what we
call the capital asset uncertainty market (CAUM). As a consequence,
companies of all sizes are now able to obtain some of the fixed assets
they require with the provision to terminate a lease or hire contract
subject to certain conditions. The practice of using CAUM to obtain
fixed assets, conserve funds, and enhance flexibility is widespread, but
it is limited by the degree of asset specialisation.
1
Real options are the options companies have when making capital investment decisions.
A company has the option to invest in such a project but can delay the decision. It can
also put an existing operation on hold, it can expand an investment or reduce it, and it
can also invest in flexibility, e.g. by purchasing versatile equipment.
2
Methodology
Interviews, a postal questionnaire, and case studies were employed, recognising
the different aspects of investment decisions that each method can reveal.
The 50 interviewees were exclusively directors with overall responsibility for the
investment analysis and financing arrangements in their companies, with the
exception of one that was with a consultant mathematician. Further details are
included in Table 1:
Table 1: Interviewee and company information
Number of Position Sector Firm Size &
Interviewees Ownership
7 Finance Director Manufacturing Large Listed
11 Finance Director Services Large Listed
3 Finance Director Manufacturing SME Listed
3 Finance Director Manufacturing Large Unlisted
3 Finance Director Services Large Unlisted
12 Finance Director Manufacturing SME Unlisted
10 Finance Director Services SME Unlisted
1 Consultant Mathematician
50
The second method of collecting data was a postal questionnaire, developed
on the basis of information gained from the interviews. The postal questionnaire
also facilitated investigation of the differences between entrepreneurial and
average performing firms, listed and unlisted businesses, large companies and
SMEs, and manufacturing and service firms. A summary of the 240 respondents
is set out in Table 2.
Table 2: Postal survey respondents by sector, size, and ownership
Listed Unlisted
Manufacturing Services Mixed Manufacturing Services Mixed
SME 4 8 2 11 100 7
Large 26 25 9 18 28 2
Total 30 33 11 29 128 9
Third, a collection of 12 firms had their investment decision-making process
investigated as case studies focusing on the complete process, and whether
there were any significant differences between entrepreneurial and average
businesses. The 12 businesses all engage in capital investment decisions. Seven
have given their approval for the publication of these cases and two examples
are included in this Briefing.
To differentiate between entrepreneurial businesses and average performing
firms some relevant performance measures were employed. Only businesses that
are in the upper performance quartile on all the measures simultaneously were
included in the top-performing entrepreneurial category. All firms used in the
sample selection had been in business for at least five years.
2
Owner-managers of private firms are known to have a variety of motives for operating their
businesses. Some seek to enrich themselves by withdrawing large salaries from their
companies, while others may choose to draw very small salaries to finance their business
activities and expansion. When calculating ROCE for private companies average directors
remuneration for each business size band was used and profits were adjusted for the
differences between actual and expected salary.
3
The following performance measures were employed:
Sales growth, calculated for quoted and private firms as their average turnover
growth rate over three years.
Return on capital employed, estimated for quoted and private firms using a
standard and research and development adjusted measure of return on capital
employed (ROCE) to obtain average ROCE over three years.
2
Market valuation of firms (for quoted companies only), market to book value
was used as a performance measure as it reflects market expectations of
company performance.
By studying established entrepreneurial and average performing firms, this
project looks for what can be learnt from their decision-making process to form
guidelines for best practice.
Some background on capital investment decisions
A complicating feature of most capital investment decisions, which are to some
extent irreversible, is the difficulty in predicting future events that could impact
on the returns from such investments. In the past, best practice in investment
appraisal has been to predict expected returns and use a risk-adjusted discount
rate to obtain the present value of payoffs. This practice facilitates comparing
one investment with another using the present risk-adjusted value. Rising levels
of uncertainty about future events, however, complicate the process. Further, the
more distant into the future a payoff is, the higher the uncertainty it is likely to
be subjected to. This line of thinking, together with the interlinking of
investment decisions with strategy, led to the development of real options
models that consider investments as a collection of options to be exercised.
This research looks at the investment decision-making process in general with
a special focus on investment and risk appraisal within that process. By studying
successful entrepreneurial firms, we consider what can be learnt from their
decision-making process to form guidelines for best practice. Although there is
no mechanical solution to the investment decision-making problem, it is helpful
for companies to think through the issues using a theoretically and practically
informed set of key features of successful processes.
The investment decision process
The making of a decision to invest is a multi-stage interactive process. From
initiating an investment proposal, through appraisal and approval, to
management of implementation, the process involves making predictions about
the future using imperfect information. Moreover, the stages of the process are
overlapping and interconnected. A rigid bureaucratic investment decision
process has been highlighted as a possible hindrance to good investment
appraisal and performance. There is little evidence that this is so. The commercial
concerns included in this study show no relationship between degree of
formality and performance; rather, formality has more to do with size and the
need to establish guidelines and processes throughout large businesses that
facilitate the comparability and predictability of investment choices.
There are, however, important points to be considered in the design of an
investment process. Entrepreneurial businesses that aggressively seek growth
and increased profits do not limit their investments to projects with quantifiable
expected outcomes. They also rely on qualitative assessments. These businesses
overcome problems with subjective judgments about the outcomes of
4
investments by being problem solvers and accepting the limits to predictability.
They accept the inevitability of deviation from expectations and keenly monitor
project progress so that problems can be rectified as they arise. Post audits are
also important as a crucial step in the process of learning from mistakes and
identifying shortcomings that may be avoided or overcome through better
process design.
Many businesses in the service sectors are able to avoid, to some extent, the
investment problem by resorting to CAUM where fixed assets are available for
lease, rent, and hire. Capital investment decisions can now be seen in the
following framework (Table 3):
Less successful firms may resort to CAUM because of lack of funds and even the
successful smaller companies tend to feel there is a need to conserve liquid
resources. Larger companies, who mostly do not suffer from a lack of funding,
seek flexibility through use of CAUM. These choices are summarised in Table 4:
The availability of market solutions to the investment problem through the
provision of fixed assets on a lease, rent, and hire basis using CAUM depends
upon how specialised the assets are. Alternatively some firms reduce their fixed-
asset base by outsourcing certain manufacturing processes (e.g. by purchasing
complete sub-assemblies).
The role of real options models
Many facets of investment decision-making problems resemble real options.
Businesses often have the option to make an investment but are not obliged to
do so. They can postpone, expand, reduce, abandon, or put-on-hold a project.
They can also invest in added flexibility to reduce the problem of irreversibility
associated with investment in many types of fixed assets. Managers often behave
in ways that are consistent with real options models, especially in dynamic
growing businesses. They are aware of the impact that the irreversibility of capital
investments has on the decision-making process. They often seek ways to mitigate
the effect of irreversibility, such as delaying decisions to wait for better prospects,
requiring higher returns to offset perceived downside risk, obtaining flexible
assets where available, and using operational leases with conditions that allow for
technological upgrades and termination of agreements whenever possible.
Table 4: The role of CAUM
Firm size
Firm performance Large firms Smaller firms
Successful Important for increasing Use to conserve funds, and
flexibility enhance flexibility
Less successful Some use to increase flexibility Use to provide access to the
necessary resources
Table 3: The capital investment decision today
Sector Large firms Smaller firms
Manufacturing Often, specialised assets make Specialised assets may make purchase
purchase necessary, confidence necessary, otherwise use CAUM
is another motivator
Services Business confidence leads to Use CAUM, unless assets specialised
purchase, but specialised assets
can be important too
5
In general, high performing firms attach relatively more importance to being first
in new opportunity areas. This reflects their aggressive stance on investment.
They also value flexibility more than average performing firms. Intuitively this is
in line with first-mover advantages and with the use of flexibility to reduce the
comparatively higher uncertainty facing a pioneering investment. Businesses also
tend to have a variety of investment projects with different characteristics, and
the majority of businesses surveyed report that from time to time they have to
delay investment projects. The presence of real-options-like thinking is even
clearer in strategic considerations for investment projects.
Although the real options models as presented in academic work and in highly
specialised practical applications are unlikely to be widely adopted, the
underlying thinking can be very useful when explicitly applied to investment
evaluation. There is evidence of firms using simpler versions of real options
models to evaluate their investment opportunities.
A schematic of the investment decision-making process using real options
thinking is presented in the appendix at the end of this Briefing.
Investment and risk appraisal
Evaluation of investment proposals involves appraising both an opportunity
and its risk as a single step in the investment decision process. The spread
of computers and software has made DCF techniques such as NPV and IRR
applicable even by smaller companies. This, however, has not reduced the
popularity of the simpler payback technique that uses the time to recouping
investment outlay as a decision rule. Such an approach is in line with the
thoughts underlying some real options models. The more distant into the future
a payoff is, the more uncertain it becomes. Businesses are more concerned with
the under-performance of investments because of the serious financial
consequences that may entail, and seek to limit their forecasting errors by
preferring projects with a relatively short payback time. Combining DCF
techniques with payback to evaluate payoffs beyond a payback time limit offers
a simple, albeit crude, risk management alternative to complex risk modelling.
Furthermore, using scenario and sensitivity analyses helps create informed upper
and lower confidence limits to enable management to make judgments about
the robustness of assumptions underpinning an investment proposal.
Many companies, and in particular large successful businesses, tend to see the
various capital budgeting techniques as alternative ways of looking at an
investment opportunity, each revealing some aspects of the decision but not
others. They often use several techniques to capture as many facets of a project
proposal as possible. The ad hoc approach to uncertainty analysis can be
improved by making the process formal and explicit. A refined approach can
also help firms that are not aware of real options models, to improve their
decision-making.
Successful firms look at their collection of investments when considering a capital
expenditure proposal. Companies aggressively seeking to expand will have a
different threshold for risk to less ambitious firms. They limit their exposure by
combining a number of projects of different risk characteristics while developing,
on a continuous basis, risky projects that, if successful, would lead to high
returns. This practice together with being problem solvers is the main distinction
between high and average performing businesses. Average performing firms
tend to be less aggressive, but they can also be limited by factors outside their
control such as the technology used in their sector or intensive competition.
6
Case study 1 highly successful UK multinational
This highly successful company is a large multinational based in the UK. It has
global competitors who hold equal market share to its own. Competition is
mostly based on innovation, and therefore research and development (R&D)
plays an important part in the success of this firm. Although it is a large
company, it only has competitive advantages in certain product areas, and these
advantages are the result of innovation.
The business generates investment opportunities through R&D that is itself
motivated by the need for a product in the market. Investments are mostly
management initiated for strategic reasons, customer and demand initiated,
and R&D initiated when some basic research calls for further investment.
Strategic reasons on occasions limit the search for investment opportunities
to areas of existing competitive advantage.
When proposing investments, the company considers proposals made by
teams that include at least one person in a position of profit responsibility. Ideas
requiring investment may emerge from an individual but additional people
are drawn in to make a formal proposal, and amongst those staff there has
to be a line manager or regional manager. Decisions are classified into five
separate categories. Categories one and two are approved by finance people
at positions lower than the finance director as they generally involve relatively
small investments. Other categories are submitted to the finance director for
approval. All through the process proposals are presented formally and in a
detailed manner.
At the preliminary selection stage a group of individuals, including the finance
director, form a committee to consider the suitability of a proposal to the
companys product portfolio. This committee looks at the quality of the initial
research, the commercial case for the investment, and the likely effect it would
have on the companys strategies. Scientific and regulatory risks are important
in defining the form the investment should take. When projects are hard to
quantify because of unknown demand and prices, the company builds its own
demand curve and investigates optimal pricing by looking at price-valuation
options. Projects are not eliminated because quantification of returns is not
possible, but at later stages as an investment takes shape attempts at calculating
returns are made to see whether a project should continue. Usually there are
plenty of projects at various stages of development to be considered for funding.
Different people carry out the evaluation of alternatives at the various stages
of product development. Payback, NPV, probability-adjusted NPV, sensitivity
analysis, and an intuitive sense of real options are all used in investment
evaluation in categories three and above. The reason for using so many
techniques is to look at and compare the different results emerging from the
techniques. At stages one and two, often there is not enough data to carry out
much calculation.
The flexibility of projects is considered as valuable and often a qualitative
judgment is made about the worth of flexibility; mothballing and postponing
options are often exercised until circumstances change. The finance director
of this company stated that investment decisions are often delayed to wait for
clearer prospects, with a quarterly review of delayed decisions. The main factors
responsible for delaying investment decisions are uncertain demand and
technical/scientific issues, with internal and external funding being of little
importance. Interest rate uncertainty is unimportant. Most of the investments are
regarded as irreversible, with investments reviewed at the stage where they pass
from one category to another. Although projects may have different
7
characteristics, the same techniques are applied but with different interpretations
of the results.
The company has a distributed finance organisation so communication must be
formal. The portfolio committee authorises projects in categories three and four.
Category five projects are authorised by the board of directors. The time taken
to reach a decision on a project varies with its size and importance. Decisions
involving substantial amounts of money require a lot of data and analysis.
Approximately, it takes three to six months to approve substantial investments.
Some rejected projects are sold to other companies, while lessons learnt from
research are added to the knowledge data bank. The proportion of authorised
projects from the total proposals received is observed.
Monitoring occurs when projects move from one category to another, with
results included in the internal annual investment report. It is difficult to monitor
progress and a lot of resources are required in order to do this. Projects that do
not perform to expectation may be brought back on track. This is quite often
achieved by investing more in order to solve the problems faced.
The chief executive officer and the finance director conduct quarterly post
audit reviews where all projects are looked at by observing sales volumes,
market penetration, and other performance indicators to see by how much
the investment is deviating from expectations. By considering projects for
progression from one category to another until they reach the market,
expectations are usually not too wide of the mark. Post audits are seen as
beneficial despite their cost because they highlight problems with project
evaluations and instigate ways of dealing with deviations from expectations
and improving procedures for the future.
Case study 2 highly innovative small company
Being a small privately owned company has not prevented this business from
being highly innovative, fast growing and profitable. It operates in a low growth
market with an expansion rate of between 05 per cent per year. It has about
27 per cent share of the market and three main competitors with roughly the
same share as its own. It is difficult for new firms to enter the market and also
difficult for buyers to find substitutes.
The company currently has excess capacity. Investments are usually to increase
efficiency or for capital replacement and are operations or demand initiated.
R&D is also important. Individual managers or management teams make
investment proposals. The proposals become formal once they reach the senior
management level, and comprise market data, models, engineering and cost
evaluations.
Management makes preliminary selections using payback. For payback periods
of one year or less, the approval is almost automatic. Projects with up to five
years payback are considered, but projects of a strategic nature are considered
for any payback period and even if the initial investment is never recouped.
Being a small firm, management knows all the projects in progress and considers
interaction amongst them and between new and existing investments. Projects
that are hard to quantify are considered using estimates or reckoning. Inability
to quantify projects does not necessarily eliminate them. Usually a long list of
different projects is considered and priority is given to the more urgent or
important proposals.
8
Senior management evaluates the alternative projects. Payback is used and, once
a payback period is acceptable, DCF in the form of IRR is applied using computer
software. Sensitivity analysis is conducted to deal with uncertainty. When projects
with a relatively long payback time (i.e. three years or more) are subject to a lot
of variability in the sensitivity analysis, delay is considered until market conditions
improve or prospects become clearer. Equipment purchased tends to be highly
specialised and made to order and thus irreversible. Flexible plant is not an option
that is frequently available for the company but high quality equipment that can
have multiple uses is chosen whenever possible. To deal with uncertain interest
rates and the prospect of inflation the discount rate is loaded to make sure the
assumptions are robust. The most important factor in delaying investments is
demand uncertainty. Internal funding constraints are moderately important and
external funding is of average importance. Investments may be scaled back in
response to economic circumstances but not as a result of operational or financial
constraints.
Senior management communicate evaluation outcomes to the people responsible
for proposals using formal and informal channels. Authorisation for commencing
work on projects is given by senior management, which meets once a month to
look at a number of issues including investment projects. Projects that are not
approved at a meeting but are seen as worthy of future consideration are revisited
on a monthly basis to see if sufficient factors have changed to warrant re-appraisal.
A project development team is responsible for following up projects, mainly
looking at scientific issues in a formal manner. This process is difficult and tends
to focus on technical problems, which may lead to cost escalation or even failure
if not resolved. When problems are identified, action is taken to address them,
sometimes with further research and development or re-formulation work.
A member of senior management who authorised the project carries out the
post audit. Usually this is conducted 12 months after start of work, and it seeks
to determine whether initial expectations have been met. Post-audit is regarded
as beneficial and the process is not costly.
Lessons from the case studies
The 12 case studies conducted were designed to reveal organisational differences
between high performing firms and average performers insofar as the investment
decision-making process is concerned. We looked at the market conditions faced
by firms and found little evidence of dominance in the market place for successful
firms. However, favourable market conditions seem to have assisted firms in the
high performing categories. Sector conditions do have some influence on business
performance. However, not all firms from buoyant sectors perform well, and the
variety of company activities in the set of case studies gives some useful indicators
for well-designed investment decision-making procedures.
Successful firms tend to be more aggressive and demanding of their investment
generation process. They regard investment to be essential to their future growth
and profitability. They are more prepared to accept projects with less clear
prospects, taking more risk but expecting greater rewards. Management demands
very high standards of analysis and implementation with procedures to observe
progress and identify weak performance as early as possible. These firms also
conduct post audits to learn from mistakes and improve administrative
procedures. This behaviour is absent from a number of average performing firms,
with one firms finance director highlighting problems with the process and
noting that the board had failed to make improvements.
9
All companies pay attention to strategic issues and new investments are restricted
by their existing strategies. Top management does, however, take strategic
decisions that change existing restrictions. This may be a further source of
difference between average and top performing businesses. In general, successful
firms tend to be very aware of strategic issues, the importance of quality and
value, and the need to work on problems emerging from investment decisions
to find solutions. Real options thinking helps integrate investment and risk
appraisal with strategic thinking, an activity successful companies attempt to
achieve using what tools they have. The element of uncertainty present to some
extent in all investment decisions makes it important to explore the impact of
possible future events on projects and on the company as a whole.
Conclusions and recommendations
Capital budgeting with its traditional assortment of techniques, although a
crucial activity for companies regularly needing to purchase capital assets in order
to prosper, is no longer a relevant process for all businesses. Many firms acquire
fixed assets because they simply need them and evaluate their decision using a
framework that is consistent with real options thinking. They investigate options
open to them and evaluate these with their eyes on goals and strategy.
The market has also developed solutions to reduce the impact of uncertainty
on business operations through leasing, hiring, renting and outsourcing (CAUM).
These types of solutions help smaller firms with both the conservation of limited
financial resources and the provision of enhanced operational flexibility. In
contrast larger companies face fewer financial constraints and so primarily use
these solutions to enhance their flexibility. Access to leasing, hiring, renting and
outsourcing, however, is limited by the nature of a companys business activities
and how much it relies on highly specialised equipment.
Confidence in a businesss market position is also an important factor in
determining whether a company invests in capital assets, given that such assets
tend to have purchase, set up and installation costs and a degree of irreversibility.
Firms that apply investment appraisal regularly deploy concepts that are in line
with real options models. Finance directors frame and subsequently manage the
investment process by looking at the options available and their financial and
strategic values. The application of such concepts is more apparent in successful
companies, possibly as a result of a better understanding of their business
environments.
Investment decisions are made in the context of strategy. In line with real
options models, strategic considerations are crucial when evaluating investment
opportunities. This is something that is ignored by basic DCF methods of
investment appraisal. Practitioners appreciate the limitations of traditional
investment appraisal techniques and apply a range of measures to highlight
different aspects of the proposed investment, as follows (Table 5):
Table 5: Using a range of measures provides information about different
aspects of the investment projects potential
Technique Result
PB Approximate time to break even
IRR The present value rate of return on an investment
NPV The total expected present value of all cash flows
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The choice of investment appraisal techniques appears to depend on the
circumstances that surround the investment proposal. In evaluating acquisitions
of other businesses, for instance, DCF methods are used because the nature
of the investment and its lengthy time horizon is inappropriate for employing
PB. Generally, in making long-term commitments, as is often necessary in
R&D projects, businesses cannot expect PB to come quickly.
Successful entrepreneurial businesses have a very proactive approach to
investment decision-making. Accepting that prediction is fraught with inaccuracy,
they closely monitor projects for any signs of failure to fulfil expectations and take
appropriate action to remedy problems. Entrepreneurial businesses, while
acknowledging the importance of short-term performance, attach a great deal of
weight to strategic and other long-term investment opportunities, e.g. by valuing
first mover advantages. Producing numerical estimates of expected investment
performance measures is important but in the absence of reliable figures
qualitative assessments are used to evaluate opportunities.
In summary the main findings of this Briefing are:
Market mechanisms such as leasing, renting, outsourcing and subcontracting
enable many firms to avoid some or all capital investment decisions.
Successful firms take a problem-solving approach to investment decision-
making and the management of projects, accepting that problems are part
of the process and making sure they are detected and dealt with early.
Choosing a collection of projects that limit the companys exposure to risks,
while ensuring that opportunities for growth are not stifled, is an approach
to the management of investments that is often adopted by successful firms.
Business success depends on market conditions, but what distinguishes
entrepreneurial businesses is their aggressive pursuit of opportunities and
determination to make their investments a success.
Successful firms are not necessarily discouraged by projects that cannot be
expressed clearly in financial numbers. They rely on qualitative and intuitive
assessments, and on their early detection and problem solving capabilities.
Simple practical techniques are used to approximate the values of investments
and the options available to companies. The use of the simpler payback
technique is in line with thoughts underlying some real options models.
Thinking about investment opportunities in real options terms by looking
at flexibility, expansion, mothballing, scaling down, reversibility and
abandonment, and any other relevant decision options, helps to identify key
features of the opportunity that should make the structure of an investment
clearer to decision-makers.
Combining DCF techniques with payback to evaluate payoffs beyond a payback
time limit offers a simple risk management alternative to complex risk modelling.
Furthermore, using scenario and sensitivity analyses helps create informed upper
and lower confidence limits to enable managers to make judgments about the
stability of assumptions underpinning an investment proposal.
The application of investment and risk appraisal effectively requires a thorough
appreciation of the information yielded by the investment appraisal methods
employed. For understandable reasons firms are generally keen on employing
PB, but for innovative investments it is unlikely to be a basis for good
investment decisions. Growth and profit seeking firms need to look beyond the
PB period to see whether, given the companys risk preferences and strengths
and weaknesses, a longer-term view can be beneficial for the future.
Finally, to summarise these findings the traditional approaches to capital
investment decision making are contrasted below with the more dynamic
processes observed in entrepreneurial businesses (Table 6):
Table 6: Contrasting approaches to capital investment decision-making
Traditional Dynamic
Perspective Tactical Strategic
Proposals considered Independently Part of the businesss portfolio of
projects with a variety of risk and
return profiles
Extent of quantification Only considered if fully Quantified where possible,
quantified but judgement and reckoning
also used
Point where decision is Single point of approval Multi-stage process
approved
Nature of decision Go/No go Options identified and considered
at each stage e.g. postpone,
conduct trial, complete phase one
only, proceed to next stage, scale
up or down, abandon
Location of responsibility Project proposer No project approved unless Board
for success member takes ownership
Appraisal techniques DCF regarded as superior, PB, NPV, IRR, sensitivity and
but PB more widely used scenario analyses each used to
provide a variety of perspectives
Monitoring of progress Yes, but data collection and Very tight monitoring, rapid
feedback takes time feedback and swift action
Post investment audit Rare Mandatory
11
12
Appendix: Options-based investment decision-making process
New Investment Proposal Idea
Assemble data, identify options available (e.g. expand
project), determine degree of reversibility, prepare case
& submit proposal for screening in the organisation
Value the option to divide the project into
stages & proceed in this way if beneficial
Are (some) assets
available from CAUM?
Is there value in reducing impact of
uncertainty by increasing flexibility
or conserving funds using CAUM?
Use Payback & NPV to determine the distribution of cash flow over
time of various project configurations and options. Use sensitivity
& scenario analyses to establish boundaries and (subjective)
probability of outcomes. Consider interaction with existing projects
Consider whether the
options to: abandon,
mothball, and scale back are
relevant, and value them
Consider timing option; is there a first
mover advantage? If not, is it beneficial
to wait for clearer prospects?
Use reckoning and qualitative
analysis, establish if project is
strategically important or has
some other source of importance
Invest and monitor
progress. Take swift
action if problems arise,
considering options
available
Further stages
to implement
Fully qualified?
Use CAUM
Post audit
Yes
Yes
Yes
No
No No
No Yes
ibc1
About the author
Francis Chittenden
Francis Chittenden is ACCA Professor of Small Business Finance
at Manchester Business School. Before becoming an academic,
Francis was a practising accountant whose work experience had
also encompassed manufacturing industry, distribution, retailing
and banking. During this time he founded or co-founded four
businesses. Professor Chittendens current research interests include
the impact of the tax and regulatory regime on owner-managed
firms, cash flow management, capital investment decisions, and
the capital structure of SMEs.
Mohsen Derregia
Mohsen Derregia is a doctoral candidate at the Manchester
Business School, researching capital investment decision-making
and uncertainty. He was appointed as a research assistant to carry
out this project. Mohsen has a first degree in management science
and mathematics from St Andrews and an MBA from Edinburgh
Business School. He joined Manchester Business School after
spending several successful years as an entrepreneur.
A full research report entitled Capital investment decision-making:
some results from studying entrepreneurial businesses by Mohsen
Derregia and Francis Chittenden has been published by the Centre for
Business Performance and is available for sale priced 20. For further
details, please visit www.icaew.co.uk/centre, click Publications and
select Enterprise category.