9609 · 10.3.4
Investment appraisal decisions — FAQ
Frequently asked questions for 9609 Investment appraisal decisions. Direct answers first, then deeper explanation — then practise with marking.
Isn't the project with the highest NPV always the best one to choose?
Not necessarily. While a high positive NPV is a very strong indicator of a good investment, it is not the only factor. A project with a slightly lower NPV might be chosen if it has a much shorter payback period (vital for a firm with cash flow problems), carries significantly less risk, or aligns better with the company's core strategy. The final decision must be holistic, not based on a single metric.
Are qualitative factors just subjective opinions that can be ignored in favour of hard data?
This is a common misconception. While they are non-numerical, qualitative factors represent real and often significant business risks and opportunities. For example, poor employee morale can lead to higher staff turnover and lower productivity, which have direct financial costs. A damaged brand image can cause a long-term fall in sales. These factors are crucial strategic considerations, not just 'soft' opinions.
If NPV is theoretically the best method, why do businesses still use ARR and Payback?
ARR and Payback remain popular for their simplicity and practicality. Payback provides a quick measure of risk and impact on liquidity, which is critical for many businesses, especially smaller ones. ARR is easily understood by non-financial managers and links directly to the Return on Capital Employed (ROCE) ratio used in published accounts, making it easy to see a project's potential impact on reported profitability. They provide different, complementary perspectives to NPV.