Appraisal techniques used in evaluating capital investments: conventional and the real option approach

Abstract

A Doctoral Thesis. Submitted in partial fulfillment of the requirements for the award of Doctor of Philosophy of Loughborough University. Firms have been found to use different methods when evaluating their capital investments, and may also be using multiple appraisal methods. Few explanations have been provided to adequately account for the differences in the firms' choice of appraisal techniques. The purpose of this research is to empirically investigate and to explain the existing capital budgeting practice by Malaysian manufacturing firms, particularly when faced with real options situations and advanced manufacturing technology (AMT) investments, and to understand the factors that contribute to the selection of the appraisal techniques. The main motivation and focus is provided by the literature on options theoty. Given previous evidence of the general non-usage of options theory, the research will consider whether the theoretical reasons for the use and non-use of options theory apply to the selection of capital investment appraisal techniques in general. Two theoretical frameworks, contingency theoty and technology acceptance model (TAM), were adapted for this purpose. Using postal questionnaires, responses from eighty-eight firms were found usable. It was discovered that few firms consider real options theory when evaluating options situations. Thus, the complementary hypotheses based on the use of sophisticated capital investment appraisal techniques were used, instead of the real options usage. Interviews were also conducted to supplement the findings from the survey. Tests on the validity and reliability were conducted. The contingent variables largely factored in an acceptable way except for strategy, but technology acceptance modelling (TAM) was rejected as an overall theory because of its poor results of factor analysis. However, the TAM variables were used in the analysis as individual variables since their reliability does not appear to be a problem. The results indicated that majority of the Malaysian firms both prefer and use the techniques of payback, personal judgement, internal rate of return and net present value. The findings also showed that these techniques were also used when faced with options situation and in the evaluation of AMT investments. Multiple regression analysis was carried out on the contingent variables. As the firms were known to use more than one technique in their investment selection process, cluster analysis was used t9 group firms that share usage patterns, and were analysed based on these groupings. The results from the analysis showed that there was little evidence of the contingency factors affecting the firms' usage of appraisal techniques. However, the analysis of individual TAM variables revealed some interesting findings. These cluster groups are found to be significantly different for the usefulness and satisfaction gained from using the techniques. In summary; this study has reported the techniques frequently used by a majority of the Malaysian manufacturing firms, and actions taken when faced with options situation and AMT investment decisions. It showed that there was some consideration and barriers in improving their capital investment appraisal practice.