There may be qualitative effects from investments decisions that could indirectly influence an organizations financial performance, therefore ‘In making important financial decisions managers must at times give more weight to non-financial and qualitative factors than to financial ones’ (Horngren, et al. , 1999: 434).
For Example a proposed capital investment may increase profitability, however if this investment has detrimental effects on employees, environment and local community, such as the proposed T5, which will result in pollution, noise and blight (‘Friends of the Earth’ fear the new roads needed will lead to flooding, and have potentially significant impact on the water quality of the River Colne and also the habitat of migrating birds and rare wildlife), then the investment should not go ahead as the benefits do not exceed the costs involved.
Investment appraisal techniques enable an organization to assess the financial benefit of a programme against alternative options. This assumes that there are other options; however an investment is not an option if it is essential to accomplish organizational objectives, regardless of being financially profitable or otherwise. For example from a strategic point of view an organization may need to be in a certain market, regardless of what the numbers say.
In relation to T5 with a 60% increase in passengers a year expansion is vital as its position as Europe’s Gateway would be lost to rivals Paris and Frankfurt who have already put plans in to extend their own airports. This illustrates the importance of the identification of non-financial factors as this can lead to long-term improvement of the financial factors. (This can be achieved using a ‘Balance Score Card’) Firms must consider factors such as the reliability of suppliers.
With reference to T5 a reputable supplier, despite charging a premium, may prove more cost effective regarding the management of ’16 inter- connecting core projects’ to prevent incurring costs due to delays or out of sequence activities. However there are limitations to non-financial and qualitative data. Different sources may give conflicting advice, for example managers tend to be very enthusiastic about their own sphere of responsibility (Bromwich & Bhimani, 1994) which may result in optimistic projections (e. g.
marketing manager will be sure air travel demand will increase). Plus managers may be persuaded to back the person rather than the project, without assessing the investment itself. Conclusion As well as taking into considerations the non-financial aspects of investment appraisal mentioned above, managers should base their decisions regarding which investment appraisal method to use depending on the project size, project duration, how quickly they need the results and depending on what they value more: long term profit or quick repayment.
They need to be aware of the strengths and weaknesses of each approach and when possible use more than one technique in order to receive the most accurate predictions. While ARR is a profit-based method, IRR requires detailed long-term cash flows and therefore can sometimes be difficult to calculate for simple investments.