Aside from the quantitative aspects, project appraisal should be subjected to qualitative scrutiny. The following is a suggested process towards investment.
Idea generation: the creation of a culture and system that encourages people within the organisation to come forward with ideas for future projects or improvements to existing ones. An atmosphere that allows investment ideas to surface and to evolve can be a significant competitive advantage for a firm.
Sponsorship of a project might involve: - presenting the idea to others who have specialist expertise helping to test the idea and shed light on the project’s viability - considering how the investment fits with the strategic direction of the business - evaluating the project using the discounted cash flow techniques as well as more traditional techniques such as payback - applying for authorisation and funding - taking a leading role in the project implementation; and - helping to assess the project as it is being undertaken to see if it lives up to its promise, to learn from mistakes and to control a run-away cash outflow.
Develop proposals and classify: ideas need to be examined in more critical detail as the data collected increases and estimates of future cash flows are refined. Major capital expenditures are treated differently in the evaluation process from more routine investments as it would be very expensive to apply sophisticated analysis to all projects.
A suggested classification of projects: New products; Expansion or improvement of existing products; Equipment replacement; Cost reduction; Statutory and welfare
Screening, strategy and budget: Proposals need to be screened to filter out those that will not go forward to detailed project appraisal, so as not to over-burden managers with numerous evaluations. Many will not taken further because they do not fit the strategic direction of the firm or because of some other limitation. To some extent (especially in the long-run) the budget can expand or contract depending on the availability of positive NPV projects.
Appraisal: detailed cash flow forecasts needed for the appraisal of projects using NPV or IRR.
Report and authorisation: NPV, IRR, payback and ARR are often presented, together with a description of the project in qualitative terms and a risk analysis in ‘capital appropriation request forms’.
Capital expenditure controls: While the investment phase of a project is underway managers track it to ensure that if there are delays or costs different from the plan they can take corrective action quickly.
Post-completion audit: monitor and evaluate the progress on the project by comparing forecast cash flows with actual cash flows over many years. Reasons for post-completion audits can be summarised as: To control the progress of the particular project under consideration; The knowledge gained from regular reviews of previous projects helps future capital investment decision-making; Psychological impact on managers.
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