FAP Essay Example | Topics and Well Written Essays - 1250 words

FAP - Essay Example Academics prefer the net present value (NPV) method because it has theoretical validity; accounting managers tend to use the internal rate of return (IRR) method (Lefley & Ryan, 2005). Surveys and case studies have been conducted to pinpoint managers’ feelings on the theoretical versus the practical applications of capital budgeting (sometimes termed capital investment appraisal). Even though considerable research has been undertaken, no definite conclusions have been drawn as to why managers reject academics’ recommendations on sound theoretical models (Lefley & Ryan, 2005). The more sophisticated theoretical models have been studied in relationship to improved firm performance (Pike, 1989), with inconclusive results. The NPV method has some shortcomings; the value added can be measured for most investment decisions. Other models such as payback and accounting rate of return are also useful in analysis, and managers continue to use their intuitive judgment and more basic financial models. Improved efficiency in project selection should logically lead to improved overall performance. Small & Chen (1997) suggest that combining a strategic and an economic approach results in greater project selection efficiency and higher success rates. Lefley & Ryan (2005) that this idea one step further and comment that there are three main considerations in any investment decision: economic, strategic, and project specific risk. By combining these three elements in one model, the impact of investment decisions can be more accurately pinpointed. As stated earlier, researchers and analysts have found that managers utilize a combination of risk assessment models and financial appraisals for practical investment evaluations, and prefer not to rely on any one model, no matter its theoretical soundness (Lefley & Ryan, 2005). One danger of choosing a single model could arise when subordinate managers maximize benefits and minimize costs and risks when they put