Quantitative Investment Appraisal techniques provide numerical data which is important in making investment decisions.
However, no professional business manager can afford to ignore other qualitative factors. While these non-numerical factors cannot be so easily expressed by numbers, they also may have a crucial bearing on any investment decision. They are referred to as qualitative factors of Investment Appraisal.
Let’s take a look at some of them:
- Business objectives. It is very significant to remember that any decisions regarding new investments should be taken with a detailed consideration of the aim and objectives of the specific business. It is a key consideration for the management. For example, if the business is aiming to improve customer experience leading to increased customer satisfaction, then a new investment in training programs should be given a priority. Or, when a business is planning long-term savings on overheads, then replacing physical shops, which require considerable capital expenditure, with the Internet and phone services seems like a good idea.
- Uncertainty. It should be assumed that any numerical results are neither certain nor definite. In Investment Appraisal, there will be internal uncertainties over the initial cost of investment, life expectancy of investment, residual value of investment and future net cash flows. External uncertainties will include changes in interest rates, inflation rates, unemployment rates, legal minimum wage, etc. Therefore, the five quantitative Investment Appraisal techniques (Payback Period (PBP), Average Rate of Return (ARR), Net Present Value (NPV), Discounted Payback Period and Internal Rate of Return (IRR)) will be more like a guideline for managers to use before making any final investment decision.Â
- External factors. The scope for external uncertainties emerging from the outside environment is great, unfortunately. This will include the impact on costs and revenues of different stages in the economic cycle, changes in prices of raw materials in relation to the levels supply and demand, development of new technology, improving or worsening public transportation networks, etc.
- Sustainability issues. Any negative impact on the natural environment and the quality of life of local communities should be considered carefully. The same applies to all sensitive areas regarding sustainability of the planet Earth and human life issues such as alcoholic beverages, adult entertainment, gambling, tobacco products, animal testing, fur and specialty leather, controversial weapons, small arms, abortion, contraceptives, human embryonic stem cell, fetal tissues research, GMO, military contracting, pesticides, thermal coal, palm oil, etc.
- Ethical issues. More and more societies are expecting businesses to act ethically as a result of the growing impact of pressure groups. Managers are pressured to consider wider issues in decision making than just maximizing short-term returns for shareholders. Therefore, when creating value from a new investment project, benefits of all stakeholder groups should be considered, not only shareholder returns.
- Bad publicity. Bad publicity usually stems from unethical conduct and the violation of sustainability issues. Sometimes the firm will give up on proposed investment plans because they may have negative impact on the corporate brand image, hence sales. The issue may be so serious that it will be able to dissuade managers from going ahead with the controversial project.
- Laws and regulations. Some investment projects may be forbidden by either the national or local governments. It is the duty of governmental officers to weigh up the costs and benefits to the local community of any planned investments to be undertaken. The government will almost always act in the way to protect and maximize interests of local citizens. Members of the society will often have a direct role in setting up pressure groups to make their views known when trying to achieve a particular outcome.
- Interpersonal relationships. Some investments, especially those that may threaten positive human relations within the business, such as replacing a large number of workers with machines, may be stopped from pursuing. Also, an investment that may negatively impact good customer service will most likely be stopped.
- Risk tolerance. Different business managers are prepared to accept different levels of risk. While some managers are risk-takers, others may be extremely risk averse. Which projects are chosen to move forward with, will much depend on the individual manager’s attitude towards taking risk. And, balancing the specific amount of risk against potential future profits.
- The owner’s gut feeling. In many small businesses such as sole traders and partnerships, the founding entrepreneur will rely on his own ‘gut feeling’ for what is likely to be most successful investment decision to go ahead with. Usually, smaller unincorporated businesses will conduct no formal investment analysis. The owner(s) will fully rely on their own intuition of taking an investment decision which may not be easily explained or justified with numbers.
- Different priorities. There will be conflicts regarding financial results from different quantitative methods of the Investment Appraisal. Ideally, the business should choose the projects with the shortest Payback Period (PBP), the highest percentage of Average Rate of Return (ARR) and the largest value of Net Present Value (NPV). However, the case is that ideal projects like that are not very likely to exist in the real life. Very often projects with the shortest Payback Period (PBP) will have the lowest Average Rate of Return (ARR), and vice versa. Managers will also need to make a decision whether to accept larger but uncertain profits in the long-term or smaller but certain returns in the short-term. It is not that easy to make a choice.
In summary, obviously quantitative Investment Appraisal results are necessary to make investment decisions. However, these guidelines are not sufficient for making final business investment decisions as plenty of qualitative factors of Investment Appraisal must also be considered.
The most important factor when it comes to investing is that any investment decision should be taken with a detailed consideration of the aim and objectives of the specific business.
