Practical Project Appraisal: what techniques do managers use?

It is always important that before undertaking an expensive capital project, a company evaluate it to determine whether it has the potential to increase shareholders' wealth; rather than destroy it. To this end, several appraisal techniques are used. These techniques include the Net Present Value (NPV); the Internal Rate of Return (IRR) and others.

Generally, NPV is viewed to be a much superior capital budgeting method than others. Despite this, IRR is still a popular choice among managers.

The Association of Corporate Treasurers (ACT) report indicated that companies have increased their use of discounted cash flow techniques over the last thirty years. Also, large firms are more likely to use net present value (NPV) than small firms and small firms use payback as much as the discounted cash flow (DCF) methods. Companies do not tend to select one of the techniques to the exclusion of all the others, many use three or four.

Explanations advanced for the continued use of methods other than net present value include the fact that: Practitioners take time to catch up with state of the art techniques; Each method has something positive to offer, e.g. allows easier communication of project viability or that the metric more closely relates to managerial incentives;‘True’ NPV is rarely known with any great certainty therefore it helps the decision-makers select projects if a portfolio of approaches is used to estimate project viability; Managers are not solely focused on returns to shareholders;Managers use more than one technique and switch between them so that they then can choose the method that shows the current project they are sponsoring and promoting to the rest of the organisation in the best light

Why is IRR still so popular? The following are possible explanations: Managers prefer to discuss project viability using a measure that is expressed as a percentage; Senior managers often like to separate the discount rate hurdle they are trying to achieve from the discounted cash flow calculation.