A Review of the Discounted Cash Flow Techniques on Investment Appraisal of

Question 1:

Accountants make a distinction between Capital Expenditure and Revenue expenditure

(Dyson, 2007). Dyson further says capital expenditure provides benefit to an entity for more

than one year, while revenue expenditure does so for one year. Drury (2005) refers to

expenditures of a capital nature as Capital Investments describing them in the same manner

as Dyson. Collin (2007) defines investment appraisal as an analysis of the future probability

of capital purchases as an aid to good management. In this essay, we are going to discuss

investment appraisal, supporting the argument that investment appraisal should add value to

the organisation. We are also going to analyse critically, the NPV and IRR methods as the

two main discounted cash flow techniques of investment appraisal available to management.

Drury explains that capital investment decisions are applicable to all sectors of the society

and gives examples of such decisions in business firms (including investments in plant and

machinery, research and development, advertising and warehouse facilities) and the public

sector (including new roads, schools, and airports). He also highlights the importance of such

decisions, stating that they represent the most important decisions that an organisation

makes, since they commit a substantial portion of the firm's resources into actions that are

likely to be irreversible.

Barfield et al (2004) define clearly, an Investment Decision, stating that it is a judgement

about which assets to acquire, to achieve an entity's stated objectives. This clearly identifies

an important characteristic of investments decisions made during investment appraisal, being

that, they must be aligned with the company's stated objectives and should therefore

contribute towards the achievement of the set objectives – thereby adding value to the

organisation. In other words, selected investments should be value adding.

The idea of value creation is to capitalise on...