Strategic Financial Management

Organisations are faced with various decision making choices which often requires rationality that must ultimately lead to the objective of maximising shareholder wealth. Investment decision making is an integral part of strategy (Anon 2011). The the objective of capital budgeting (Brealey et al 2006) is to evaluate investment choices to find investments worth the cost and delivering returns is a critical success factor in business strategies (Anon 2011). This essay is drawn primarily from a statement of Adler’s (2000) article. He stated that traditional investment techniques are criticized in different ways. This essay will explore into issues behind traditional techniques, analyse the reasons of these arguments with a discussion of possible alternatives that could remedy these shortcomings.

Capital expenditure decisions involves a substantial outlay and must bring benefits over a long period of time, hence requires careful analysis that have important implications for the future of organisations (Holmes 1998). The investment appraisal techniques help to avoid pitfalls, such as developing emotional interests to certain projects or pursuing personal interests other than the objective of shareholder wealth maximisation (ibid). The traditional techniques to be discussed here are payback, accounting rate of return (ARR) and discounted cash flow techniques such as net present value (NPV) and internal rate of return (IRR).

Payback

The payback method refers to the length of time the net cash flows from a project will recoup the investment (Anon 2011). Being a straightforward and an easy method, it also does not account for cash flows after the payback period and hence managers may choose unprofitable projects that yield low returns, while rejecting those that may bring low returns initially but bring greater returns subsequently in the long run (Steven n.d.). Hence it cannot be used to evaluate mutually exclusive projects (ibid) and is seen as a measure of...