Besides financial goals, companies increasingly start formulating strategic environmental goals. However, the management and control of these goals remains a challenge. Therefore, this thesis aims to develop a method that is able to systematically integrate financial and environmental data in investment processes to support the achievement of strategic environmental and financial goals of companies. This new Integrated Investing method intends to provide a sufficient degree of scientific quality on the one hand and practical applicability on the other hand. In context of this thesis, a deficit analysis assesses reasons why current methods of environmental management accounting have not established as common business practice so far. During the first part of the subsequent method development a set of seven requirements is composed. On basis of these requirements additional methods of environmental management and management accounting systems are evaluated resulting in a final set of three approaches representing the basis of developing the new Integrated Investing method. After developing and describing the new Integrated Investing method, the method is applied in seven case studies within the Volkswagen Group. This method application verifies the method’s practical applicability as well as its ability to manage and control strategic environmental and financial goals. In conclusion, this dissertation contributes to the development and application of a new Integrated Investing method that aims to ensure a sufficient degree of scientific quality and practical applicability. With the help of this method, it is able to systematically integrate environmental impacts in investment processes of companies in order to manage and control the achievement of strategic environmental and financial goals.
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How to integrate environmental impacts in investment processes of companies.
Technische Universität Darmstadt (D17)
Faculty of Civil and Environmental Engineering
Approved doctoral thesis with the intention to achieve the degree Dr. rer. pol.
Simon Weihofen, MSc.
Prof. Dr. rer. nat. Liselotte Schebek
Technische Universität Darmstadt
Chair of Material Flow Management and Resource Economy
Prof. Dr. rer. pol. Edeltraud Günther
Technische Universität Dresden
Faculty of Economics
Chair of Environmental Management and Accounting
Weihofen, Simon (2016) Integrated Investing – How to integrate environmental impacts in investment processes of companies. Darmstadt, Germany, self-published, printed by CreateSpace
Handed in on 24 September 2015, disputation on 10 December 2015, published on 23 April 2016 in Darmstadt, Germany
Oh, Mother Earth,With your fields of greenOnce more laid downby the hungry handHow long can yougive and not receiveAnd feed this worldruled by greedAnd feed this worldruled by greed.Oh, ball of fireIn the summer skyYour healing light,your parade of daysAre they betrayedby the men of powerWho hold this worldin their changing handsThey hold the worldin their changing hands.Oh, freedom landCan you let this goDown to the streetswhere the numbers growRespect Mother Earthand her healing waysOr trade awayour children's daysOr trade awayour children's days.Respect Mother Earthand her healing waysOr trade awayour children's days.
Mother Earth (Natural Anthem)
Neil Young, 1990
The results, opinions and conclusions of this dissertation are not necessarily the same as the Volkswagen Group.
Environmental management systems aim to ensure legal compliance on the one hand and continuous improvement of environmental performance on the other hand. Due to its cross-sectional character, environmental management systems affect all parts of the organisation. Another cross-sectional system is the management accounting system which intends to support ex-ante internal management decision-making processes. The overlapping part of both systems deals with environmental issues in business planning processes and is commonly referred to as environmental management accounting. However, the field of environmental management accounting is still young and corresponding methods are currently under development.
Besides financial goals, companies increasingly start formulating strategic environmental goals. However, the management and control of these goals remains a challenge. Thus, the formulation of strategic environmental goals in qualitative terms limits their management and control. On the other hand, the systematic integration of strategic environmental goals in management accounting processes, such as investment appraisals and decisions, represents a research gap.
Therefore, this thesis aims to develop a method that is able to systematically integrate financial and environmental data in investment processes to support the achievement of strategic environmental and financial goals of companies. This new integrated investing method intends to provide a sufficient degree of scientific quality on the one hand and practical applicability on the other hand.
In context of this thesis, a deficit analysis assesses reasons why current methods of environmental management accounting have not established as common business practice so far. During the first part of the subsequent method development a set of seven requirements is composed. On basis of these requirements additional methods of environmental management and management accounting systems are evaluated resulting in a final set of three approaches representing the basis of developing the new integrated investing method. After developing and describing the new integrated investing method, the method is applied in seven case studies within the Volkswagen Group. This method application verifies the method’s practical applicability as well as its ability to manage and control strategic environmental and financial goals.
In conclusion, this dissertation contributes to the development and application of a new integrated investing method that aims to ensure a sufficient degree of scientific quality and practical applicability. With the help of this method, it is able to systematically integrate environmental impacts in investment processes of companies in order to manage and control the achievement of strategic environmental and financial goals.
The recommendations for future research address the limitation of the Ecological Scarcity Method, on which the integrated investing method is based, as well as the application of the new integrated investing method in contexts outside the Volkswagen Group.
This thesis evolved in context of my time as a doctoral candidate at the Volkswagen Group Research Environmental Affairs department, in which I had the pleasure to support the environmental management team. During the first few months, while I was searching for an appropriate topic for my dissertation, the team was faced with an increasing amount of enquiries. These enquiries requested a method for a decision-making process that balances financial and environmental aspects. While the financial costs and benefits of an investment could be identified and quantified, decision-makers were uncertain about the quantification of environmental impacts associated with the investment.
The more my colleagues and I immersed into this topic, the more controversial and complex were the associated discussions, which finally led us to the necessity for a sound academic but also pragmatic solution in form of my dissertation. Hence, this thesis addresses environmental management and management accounting professionals, who are faced with similar enquiries on the one hand and the scientific audience on the other hand, which is cordially invited to discuss my proposed method.
This thesis would have never been written without the support of my family, friends and colleagues. First of all, I am very grateful to Judith for her endless support and belief in me, not only during the time of my dissertation, but also for encouraging me in whatever I have done so far – be it studying and working abroad or all of my additional projects, which mostly take place far away from our shared home. In this context, I am especially pleased to count on my grandparents, parents and my sister, who constantly believe in the success of my projects, which always encourages and motivates me.
I have also not forgotten the inspiration of Tim Kaske, who encouraged me to even think about the option of writing a dissertation. At that point of time, writing a dissertation seemed to me as an unreachable goal. Without his inspiration, I would have never applied for the job offer as doctoral candidate at the Volkswagen Group.
During my time as doctoral candidate, I had the pleasure to work together with lots of bright colleagues, who took the time to listen to my thoughts and who did not hesitate to provide valuable and constructive feedback. In this context, I am especially thankful for the constant help of Steffen Wellge in form of time, guidance, motivation, trust, creativity, open and honest feedback. Without Steffen’s support, I would simply not have been able to finish my dissertation in three years’ time and working on my dissertation would not have been that much fun.
Furthermore, I was supported by my supervisors, Günter Damme, Dr. Liendel Chang and Gerhard Mogg, who enabled me to present my dissertation to broad audiences within the Volkswagen Group Research but also in context of external scientific conferences.
I am additionally thankful for various colleagues who supported me in conducting the case studies: Kai Schweingruber, Kai Jaekel, Christian Pressel, Marius Rode, Markus Meyer, Dr. Stefan Brinkmann, Dr. Jens Asche, Marcin Grochowski, Stefan Rose, Erhan Icten, Malte Gebler, Volker
Hillers, Ralf Steffen, Carsten Weinz, Hans-Joachim Blunck, Arnd Müller, Reinhard Marowsky, Martin Müller, Markus Lange, Johannes Meichsner, Stefanie Hofmann, Florian Müller, Yvonne Thoben, Robert Schmidt, Micha Bruchmüller, Cynthie Gadiel, Vitali Hartfelder, Thomas Kitzmann, Thomas Krösche, Thomas Belger, Dr. Klaus Matalla and Silke Härtel. Thanks also to Astrid Kuwert-Behrenz, Britta Mostert and Beate Hainke who helped me with the professional layout of my dissertation and to Katharina Storm who invested a tremendous effort for eliminating all the typos in this dissertation.
Last but not least, I am very grateful for the support of my doctoral supervisor Prof. Dr. Liselotte Schebek and my second supervisor Prof. Dr. Edeltraud Günther, who not only agreed to supervise my thesis, but also took their time to provide constructive and valuable feedback, which helped me to keep focused and to solve all emerging issues.
If you have comments or if any questions remain unanswered at the end, please do not hesitate to send me an e-mail:
Academic background of the author
2007 – 2011:Bachelor of Business Administration (BBA) in International Business and Management Studies at Fontys International Business School in Venlo, the Netherlands
2011 – 2012:Master of Science (M.Sc.) in Sustainable Business at Manchester Metropolitan University Business School in Manchester, United Kingdom
2012 – 2015:PhD Student at Group Research Environmental Affairs Production at Volkswagen in Wolfsburg, Germany
Environmental management systems have experienced increased importance within companies to address public and legal environmental concerns. The aim of environmental management systems is to ensure legal compliance on the one hand and continuous improvement of environmental performance on the other hand (Förtsch and Meinholz, 2014). Due to its cross-sectional character, environmental management affects all parts of the organization. Besides managing environmental performance of existing business operations, environmental management systems also focus on business planning processes (Burschel, 2004).
Another cross-sectional system is the management accounting system. In contrast to financial accounting, which is concerned with external reporting of ex-post financial performance, management accounting intends to support ex-ante internal management decision-making processes. These decision-making processes comprise amongst others cost-benefit analyses, budgeting processes, cost allocation processes or investment appraisals. Hence, the management accounting system is also referred to as the internal accounting system. (Zimmermann, 2011)
The overlapping part of both systems deals with environmental issues in business planning processes. When building a new plant or replacing equipment, costs and benefits need to be forecasted to support the upcoming investment decision. In addition, these decisions have an impact on the environmental performance as well. This overlap of environmental information in form of physical flows with monetary information is referred to as environmental management accounting (IFAC, 2005).
However, the field of environmental management accounting is still young and environmental management accounting methods are currently under development (Faßbender-Wynands et al., 2009), leading to the subsequent problem situation of this thesis.
The strategic goals of a company are typically expressed in quantitative financial values (Hungenberg, 2012). Hence, target values in form of financial ratios or figures are formulated on company level and broken down to its organisational units. For instance, the targeted percentage of return on investment (ROI) is determined at ten percent as strategic goal. In this case, this strategic goal is broken down to the business units of a company. Therefore, the expected returns of competing investment objects are calculated and investment objects with a ROI below the targeted ten percent are excluded from further consideration. With this procedure, management accounting professionals ensure that investment decisions support achieving the targeted strategic financial goal.
Besides financial goals, companies increasingly start formulating strategic environmental goals (Burschel, 2004). Nonetheless, challenge remains regarding the achievement of these environmental goals (Liesen et al., 2013). This challenge originates from two sources, which is on the one hand the formulation of the environmental goals and on the other hand the management accounting system missing to support the achievement of these environmental goals.
Environmental goals are regularly expressed in a qualitative way. Nevertheless, to enable monitoring the achievement of strategic environmental objectives, the associated accounting ratios need to reflect the values of the strategic goals (Gladen, 2011). Hence, environmental goals need to be expressed in quantitative values. Due to the qualitative expression of environmental goals, possible conflicts with quantitative financial goals remain intangible. This conflict mainly comprises the incomparability between qualitative and quantitative strategic goals. With the establishment of quantitative environmental goals, this subtle conflict turns tangible especially with environmental management measures that do not provide any profitability (Dyckhoff and Souren, 2008). As a consequence, the decision-maker becomes aware of the environmental impacts besides the already-known financial impacts in order to come to a comprehensive investment decision.
In addition, companies need a systematic integration of indicators or ratios in the decision-making processes that is analogous to achieving financial goals. Therefore, it is necessary to link physical environmental information with the underlying monetary information of investment decisions . This physical environmental information is tracked by the environmental management system. Hence, the environmental accounting system as overlapping system intends to provide such a comprehensive data base.
However, the systematic integration of environmental management information in management accounting processes such as investment appraisals remains a research gap (Herzig and Schaltegger, 2009). While academic literature discusses possible integrated environmental investment appraisal methods, none of these methods has established as accepted standard so far.
Basing on the identified research gap in the previous subchapter, the first step of this thesis intends to assess methods dealing with the integration of environmental impacts in investment processes. This step further aims to perform a deficit analysis to identify reasons which have prevented these methods to establish as accepted standard in business. The concluding step reveals the development of a method based on the insights of the deficit analysis.
Hence, the research objective of this thesis is to develop a method to systematically integrate environmental impacts in investment decisions within companies (integrated investing method) and to verify its practical applicability. With the help of such an integrated investment decision, companies should be able to execute environmental management accounting to consequently achieve strategic environmental and financial goals. Therefore, the main research question is formulated as follows:
Main research question:How to integrate financial and environmental data in investment processes to achieve strategic environmental and financial goals of companies?
The methodology describes the way to solve the problem situation by achieving the research objective. However, to answer this research question, it is necessary to develop an integrated method that offers a sufficient degree of scientific quality on the one hand and is able to be applied in business practice on the other hand. Hence, the integrated investing method needs to meet requirements corresponding to theory and practice.
Regarding the theoretical development of the integrated investing method, the requirements originate from the outcome of the deficit analysis of existing methods. Additional requirements emerging from method development, as discussed in current academic literature, aim to ensure a sufficient degree of scientific quality. In conclusion, the first sub-research question is formulated as follows:
Sub-research question 1:Which requirements does the integrated investing method need to meet in order to ensure a sufficient degree of scientific quality?
Besides requirements ensuring scientific quality, the other aim is to ensure successful practical application of the integrated investing method. In this context, current academic literature on method development reveals a set of additional requirements which the method needs to meet. Therefore, the second sub-research question is formulated as follows:
Sub-research question 2:Which requirements does the integrated investing method need to meet in order to ensure its practical applicability?
After conducting the deficit analysis of currently existing methods and composing a set of requirements ensuring sufficient scientific quality and practical applicability, the concluding step comprises the method development. As already indicated in the introductory passage, the integrated method can be categorised in the field of environmental management accounting, which overlaps with management accounting and environmental management systems. Both systems provide methods that have already established as common accepted standard. Therefore, it is necessary to assess methods that might be able to serve as a basis of the concluding method development. To provide a suitable framework for this assessment, the previously developed set of requirements provides the basis of this method screening and evaluation. Hence, the third sub-research question is formulated as follows:
Sub-research question 3:How well do additional methods from environmental management and management accounting systems meet the requirements to qualify as a basis for the development of the integrated investing method?
Besides the compliance with requirements ensuring scientific quality, the integrated investing method also needs to be applied in a real life business context to verify its successful applicability in practice. Furthermore, the method application intends to verify whether the integrated investing method is able to support the strategic environmental goals of an existing company. Hence, the fourth sub-research question is formulated as follows:
Sub-research question 4:Does the method application verify the practical applicability of the developed method and the ability to manage and control strategic environmental goals of an existing company?
Structure of this dissertation
To describe the current state of academic knowledge and business practice, it is necessary to deal with the main object of this thesis which is the investment process. Hence, the second chapter comprises an introduction into the investment process within companies as well as the most common conventional investment appraisal methods. The second part of this chapter discusses current methods aiming to integrate environmental impacts in investment decisions. The discussion intends to identify reasons for their immaturity in practical application with the help of a deficit analysis.
Based on the results of the deficit analysis and current academic literature on method development, a set of requirements, ensuring sufficient scientific quality on the one hand and practical applicability on the other hand, is intended to be developed in the third chapter. Thus, the first two sub-research questions are answered within the first part of the third chapter. Moreover, the third chapter aims to identify and evaluate additional methods which might serve as a basis for the development of the new integrated investing method. The result of the evaluation of the identified methods according to the requirements provides the answer to the third sub-research question. The final part of the third chapter intends to comprise the development of the new integrated investing method.
The result of the method development process is described in the fourth chapter containing the description of the new integrated investing method. This method description is structured along the previously identified main object of this dissertation in form of the investment process in companies.
After having developed the new integrated investing method, the fifth chapter intends to apply the method in real life business context in order to provide an answer to sub-research question four. Moreover, this method application chapter intends to verify the method’s practical applicability on the one hand and its ability to manage and control environmental goals of an existing company on the other hand.
Finally, the validity and reliability of the results are discussed in chapter six to finally provide the conclusion and recommendations for further research within the subsequent chapter. Within this last chapter, the main research question of this thesis is going to be answered as well.
The methodological structure of this dissertation is also illustrated in Figure 1.
Figure 1: Methodological structure of this dissertation
Source: Own illustration
This chapter represents an introduction to the current academic knowledge of the corresponding issues of this thesis. While the first subchapter highlights the investment process within companies, the second subchapter discusses conventional investment appraisal methods which are commonly used in business practice. The following subchapter analyses environmental modifications of the previously identified investment appraisal methods. Finally, before the final deficit analysis summarises the weaknesses of the discussed methods, the current academic knowledge regarding environmental impact assessments in companies is introduced.
Purpose of investments
According to Poggensee (2011), investment decisions are a critical factor for the success of a company since the invested capital is bound for long time. This in turn restricts the scope of action of a company. Hence, it is important to invest into projects that support the company’s strategy so that strategic goals can be achieved. Therefore, investment decisions describe the direction of the future development of a company (Jasch and Schnitzer, 2002) and thus need to be taken with the intention to support strategic goals of a company.
Hence, the origin of the necessity for investments can be found in the formulation of strategic goals. These goals are typically formulated as financial values such as a targeted return on investment or a targeted net present value which should be added to the company value (Hungenberg, 2012). However, also qualitative goals are formulated such as a top position in an external ranking or a defined amount of patent applications (Gladen, 2011).
Strategy implementation describes the way to achieve these goals. Hence, the task of the product management is to achieve these goals with either existing products or by developing, marketing and selling new products. The underlying strategic marketing decisions are either based on a previous outside-in or inside-out analysis. While the inside-out analysis focuses on the question which products can be developed and sold on which markets with existing resources, the outside-in analysis works with the opposite perspective. Hence, the outside-in perspective starts with an analysis of the target market to derive a product idea to finally identify the internal resources necessary to produce and sell this product (Grünig and Kühn, 2011).
In conclusion, before the investment planning process is started within a company, strategic goals need to be determined and decisions regarding new product development or marketing measures of existing products need to be made. These decisions, in turn, impact on the production facilities of a company. Hence, new plants need to be established or existing plants are extended or adjusted.
The extent to which these measures are examined is limited by the capital budgeting process which runs parallel to these strategic decisions. Therefore, the marketing or sales management has to forecast sales and expected turnover which in turn determines the size of capital budgets, cost budgets and targeted profits. (Zimmerman, 2011)
The subsequent operational strategy implementation begins with comprising amongst others the investment planning process. This process serves to support the strategic goal by identifying the most efficient way of investing. (Grünig and Kühn, 2011)
The following figure provides an overview over the different purposes of investments in companies:
Figure 2: Characteristics of the investment attribute ‘purpose’
Source: Own illustration based on sources above
Scope of investments
Regarding the scope of investments, the differentiation between single investments and investment programs is vital for the investment process. As described above, the strategic goals of a company influence the investment planning process. In case the achievement of strategic goals requires investing in several mutually non-exclusive investment objects, the assessment of the best combination of these objects is referred to as investment program planning (Becker, 2012).
The scenario in which another department (e.g. sales, marketing, product management, etc.) determines the size of capital budgets is referred to as ‘successive investment program planning’. In contrast to that, the interdependencies and given limitations are recognised and sorted out in close cooperation between both departments with simultaneous programming. (ibid.) The following figure provides an overview of the different scopes of investments in companies:
Figure 3: Characteristics of the investment attribute ‘scope’
Source: Own illustration based on sources above
Process of investments
The investment processes for single investments contains six steps which are iteratively run through. First, the problem situation is formulated pointing towards an investment need. The second phase is characterised by research for investment objects which might be able to solve the previously-described problem situation. The next step comprises the appraisal of competing investment objects. In this phase, the profitability of each investment object is projected and compared to the other investment objects. While the fourth phase is defined by the actual investment decision, the investment object is realised in phase five. Finally, the last phase deals with the ex-post analysis of the originally projected profitability with the actual profitability of the investment object. (Poggensee, 2011; Prätsch et al., 2012) The following figure provides an overview over the different process steps of investments in companies:
Figure 4: Characteristics of the investment attribute ‘process’
Source: Own illustration based on sources above
Focus of investments
Prätsch et al. (2012) differentiate between two perspectives when defining investments. On the one hand, there is a cash flow-focused investment definition. Thus, investments are defined as cash flows which are characterised by outflows at the beginning of an investment with associated cash inflows at later points of time. On the other hand, there is the reporting-focused investment definition which concentrates on the financial localisation of investments within the company’s balance sheet.
Poggensee (2011) also constitutes a lack of consistency in defining investments. He identifies three popular perspectives from which to define investments. One perspective corresponds with Prätsch et al. (2012) in recognising the timing of cash flows as central point of the definition. The second perspective deals with the intention of the investment which is to acquire fixed (tangible or intangible) assets. The third perspective concentrates on the investment appraisal itself and its intention to create a basis of comparison to alternative investment objects. (Poggensee, 2011) The following figure provides an overview of the different focuses of investments in companies:
Figure 5: Characteristics of the investment attribute ‘focus’
Source: Own illustration based on sources above
Ownership of investments
Besides these capital asset-oriented investment definitions, Pape (2011) adds a financial perspective. Hence, investments can also comprise the merger or acquisition of external companies but also the acquisition of financial entities generating profit such as financial derivatives, loans, bonds or securities.
While literature on investments usually assumes the acquisition of an asset, leased assets are also part of this discussion. McLaney (2009) differentiates between operating and finance leases. While operating leases comprise hiring an asset instead of purchasing it, finance leases occur in form of sale and leaseback contracts, in which the user purchases the asset at first place, sales it to a financier in a second step to finally lease it back in order to continue its utilisation. (ibid.) Although the actual ownership is transferred to a third party (financier), the control and operation remains at the user.
The following figure provides an overview over the different ownership options of investments in companies:
Figure 6: Characteristics of the investment attribute ‘ownership’
Source: Own illustration based on sources above
Types of investments
In addition to various definitions of investments, the literature describes three main categories regarding the type of investments. The first category refers to foundational investments to acquire the first property plant and equipment allowing a start-up business to set up its operations. The second category comprises continuous investments for existing plants and equipment, for instance investments preserving production capacity such as renovation or retrofitting of existing plants and equipment. The third category is characterised by complementary investments. On the one hand, this can involve expansion of production capacity by acquiring additional plants or equipment. On the other hand the efficiency of already existing machinery can be increased by rationalisation investments. In addition, this third category also comprises diversification investments necessary, for instance, to meet the trend of mass customisation, for instance. (Prätsch et al., 2012)
Apart from these three main types of investments, the literature highlights two additional terms which roughly summarise the variety of investment categories. On the one hand, there is the term of ‘greenfield investments’ which described the establishment of new facilities from scratch. These new facilities can either serve as foundational investment or as complementary (e.g. for expansion or diversification) investment. On the other hand, there is the term of ‘brownfield investment’ which involves the acquisition of existing facilities. This might be the case for continuous investments or complementary (e.g. rationalisation) investments. (Morschett et al., 2010)
The following figure provides an overview of the different types of investments in companies:
Figure 7: Characteristics of the investment attribute ‘types’
Source: Own illustration based on sources above
Time period of investments
Another important issue regarding relevant specifications is the time period under consideration. The concept of life cycle costs (LCC) sums up all costs associated with an asset along its complete life cycle. Since the term ‘life cycle’ is used by several academic professions, it is important to differentiate between the environmental and economic definition of life cycle. Both professions refer to the term ‘life cycle’ when considering more than just the production and utilisation of a product. However, the biggest difference concerns the focus of the phases before and after production and utilisation.
While the economic life cycle ranges from research and development of the product, over production to marketing (i.e. utilisation of the product from a company’s perspective) and finally removal from the market, the ecological life cycle ranges from resource extraction to production and utilisation of the product to finally end with its disposal.
With regard to the activities prior to production, the environmental life cycle perspective considers all activities necessary to extract and process the resources needed to manufacture the product. In contrast to that, the economic life cycle perspective considers research and development activities as relevant step prior to production. Also the phases after the production and utilisation differentiate between both perspectives. While the economic perspective assumes the end of manufacturing and marketing activities of the product, the environmental perspective focuses on the disposal of the product and its impact on the environment.
According to Schebek (in Ausberg et al., 2015), both perspectives influence each other. In order to generate an environmental impact in form of resource extraction, a product first needs to be developed. During production and utilisation, the product consumes resources and causes emissions impacting on the environment. Finally, when it is not economically viable to manufacture and market the product, the impact decreases. However, at the end of the functional life cycles of the products, the disposal causes additional impacts on the environment. Hence, environmental impacts are connected to market mechanisms such as economic life cycles. (ibid.)
When discussing the concept of LCC, the economic perspective of the life cycle is assumed as underlying basis. Ideally, the costs of an asset are recorded in the different phases which are structured into research and development, production and construction, operation and support as well as dismantling and disposal of an asset (Lichtenvord et al., 2008). While conventional economic concepts of LCC focus on all associated direct and indirect costs, environmental LCC studies complement these data with corresponding external costs (i.e. environmental impacts from resource consumption and emissions) which should be internalised to represent all relevant costs (ibid.).
Nevertheless, the existence of various actors involved in the life cycle of an asset creates the problem of who should bare which costs. Especially, since the costs of one actor might be the revenues of another actor. Therefore, the term of total cost of ownership (TCO) narrows down the scope and time period of recorded costs. As Thiede et al. (2012:275) claim: “TCO subsumes all cost proportions that occur for the operator of a machine”. Examples for these subsumed costs may involve “acquisition, installation, training, energy, maintenance, planned or unplanned downtime and disposal” (ibid.:276). Additional costs under consideration might involve costs of capital and depreciation.
The following figure provides an overview over the periods of time under consideration of investments in companies:
Figure 8: Characteristics of the investment attribute ‘time period’
Source: Own illustration based on sources above
The various attributes and their corresponding characteristics which are discussed in the literature addressing investments are summarised in the following figure:
Figure 9: Overview of attributes of investments as described in literature
Source: Own illustration based on sources above
2.1.2. Attributes and characteristics of investments in context of this thesis
Since there is a huge variety of characteristics and no consistent definition of investments, it is necessary to determine the attributes and characteristics of investments for the context of this thesis.
Regarding the purposes of investments, this thesis focuses on the aim to support the achievement of strategic goals of a company, since the alternative strategy implementation does not necessarily involve investment decisions. In addition, the investment appraisals in today’s business practice are expressed along the quantified strategic goals of a company. Hence, decision-makers aim to support strategic goals of a company with their investment decisions.
The scopes of investments differentiate between investment programs and single investments. Since the sum of single investments form an investment program, the scope focuses on assessing single investments in context of this thesis.
Regarding the processes, this thesis discusses the implications of the complete investment process, ranging from investment planning, over its decision to the investment realisation. This decision is taken based on the various opportunities the complete process offers for the integrated investing method to adjust and extend existing investment practice in companies.
Concerning the focuses, the cash flow-based definition is considered as result of systematic exclusion. While the investment appraisal-based definition highlights only one phase of the investment process, the reporting-based definition is concerned about the localisation of investments in the balance sheet. This localisation, however, does not offer enough level of detail since it sums up each investment value in one aggregated figure at only one point of time within a balance sheet.
The ownership attribute differentiates between acquisition and leasing fixed assets. Due to the cash flow-based definition of investments, which recognise an initial cash outflow at the beginning of ownership of the fixed tangible-assets, leasing is not considered to be part of this thesis. In addition, the literature discusses leasing options as part of corporate financing which is also not covered by this thesis. Since the acquisition of intangible assets and financial assets do not necessarily involve an environmental impact, the acquisition of fixed tangible assets is part of the characteristics in context of this thesis.
Furthermore, the literature differentiates between several types such as greenfield and brownfield investments. The existence of environmental impacts is the reason behind the choice of investment types. As a consequence, greenfield investments as well as brownfield investments are considered within further research and discussion.
With regard to the time period under consideration, the ownership of the fixed tangible asset is considered from the operator’s view, which includes the phases described within the TCO-approach (i.e. construction, operation and support as well as dismantling and disposal).
Definition of investments in context of this thesis
Investments are defined as single investments in form of cash outflows enabling to acquire fixed tangible assets for greenfield or brownfield sites, which generate (imputed) cash inflows over the time of the operator’s ownership, aiming to eventually help a company in achieving its strategic goals.
Hence, cash outflows in form of direct and indirect costs (and also imputed cash inflows in form of avoided costs) are considered as long as the investment object is owned and controlled by the company.
The following figure summarises the definition of investments used in context of this thesis.
Figure 9: Attributes and characteristics of investments in context of this thesis
Source: Own illustration based on sources above
Investment decision vs. investment appraisal
The literature often suggests that the result of the investment appraisal already implies the investment decision. However, Prätsch et al. (2012) argue for a strict separation between investment appraisal and investment decision as the people involved within these two phases are separate persons. While management accounting professionals are responsible for the calculation of the investment appraisal, the executive management is responsible for making the investment decision (ibid.).
Poggensee (2011) also argues for a strict separation since investment appraisal methods work with simplified models trying to express reality in quantitative values. This representation of reality involves a reduction of complexity with the help of assumptions. Nevertheless, the decision-maker has to consider also non-monetary and qualitative criteria to make a comprehensive investment decision.
Another argument can be seen in the different objectives of the two phases. On the one hand, the investment appraisal intends to create a quantitative value for each investment object. The quantitative values of the competing investment objects can be compared to each other to determine their relative advantageousness. On the other hand, the investment decision aims for an improvement of the current state of the company. This improvement is achieved by adding value to the company value through the returns or saved operating expenses caused by the investment object. Hence, investments aim to enable the company in achieving its strategic goals. (ibid.)
Classification of investment appraisal methods
The classification of investment appraisal methods depends on the formulation of strategic goals which the methods intend to support. Hence, the first step is to distinguish between quantitative and qualitative strategic goals. Furthermore, the second step is to clarify whether investment appraisal methods have to support one strategic goal or whether there are several goals that have to be achieved equally. The third step comprises a differentiation between single independent investments and an investment program in which several investments depend on each other. (Poggensee, 2011)
Figure 10 provides an overview of the classification of strategic goals and the corresponding investment appraisal methods.
Figure 10: Classification of strategic goals and corresponding investment appraisal methods
Source: According to Poggensee, 2011
While static investment appraisal methods mostly concentrate on the profitability and payback period of an investment, dynamic investment appraisals recognise the points of time of cash inflows and outflows. Hence, dynamic investment appraisal methods include interest rates to calculate the net present value of an investment or the internal rate of return. Dynamic investment appraisal methods are perceived as superior to static investment appraisal methods since the recognition of the time value of money enables the calculation to produce more realistic results. (Jasch and Schnitzer, 2002)
Although static investment appraisal methods do not qualify as the only basis of investment decisions, since they lack recognising the time value of money, they are still commonly used in companies (Poggensee, 2011). One reason for this contradiction can be seen in the simple calculation enabling a quick application and rough orientation. Hence, the most common static investment appraisal methods (i.e. return on investment, payback period, cost or benefit comparison) are discussed in this thesis as well.
Risk and uncertainty in investment appraisal methods
Other important aspects when discussing investment appraisal methods are the issues of risk and uncertainty. While risk is commonly stated as the damage impact multiplied by the probability of occurrence of a negative event, uncertainty deals with the lack of knowledge about the consequences of the investment as well as uncertainty about the data quality level. (Poggensee, 2011)
However, risk management and also uncertainty originating from a low level of data quality are not in the focus of this thesis. Hence, the premise is given that the person calculating the investment appraisal retrieves data and also considers relevant risks in all conscience according to the general prudence principle in accounting.
According to a survey of Truong et al. (2008), the investment appraisals net present value, internal rate of return, payback period as well as return on investment are the most popular and thus most used among companies worldwide. Hence, the following subchapters introduce and discuss these methods in addition to further approaches completing the most-relevant investment appraisal methods in today’s practice.
The payback period (PBP) is defined as the period of time in which the invested capital is amortised by the cash inflows of the investment object. The result of the payback period calculation can be expressed in days, weeks, months or years. (Prätsch et al., 2012)
On the one hand, the existence of a payback period itself can already be regarded as an indicator of a profitable investment. Nevertheless, when comparing the relative advantageousness of competing investment objects, the investment object with the shortest payback period indicates the best alternative. This time-based view represents a basic risk assessment, as the near future is perceived as less risky than the distant future. In conclusion, investments with short payback periods express a higher chance of amortising the invested capital than investment objects with long payback periods. (Poggensee, 2011) In addition, quick cash inflows can be re-invested earlier than cash flows occurring in distant future, providing a company financial flexibility, especially in uncertain times.
Due to its simple calculation, the payback period enables quick decision-making. However, Poggensee (2011) argues that it cannot serve as single basis for investment decisions as the payback period does not recognise the lifetime of the investment object. Additional difficulties occur when comparing the payback period of several investment objects with different amounts of capital investment.
A simplified example illustrating this problem can be retrieved in Table 1.
Table 1: Simplified example for payback periods of two investment objects
Source: Own example
When comparing the investment objects given in Table 1, investment object B shows a better payback period with only one year of amortisation. Hence, the decision-maker would prefer investing in object B, assuming that no additional information is available. However, the expected lifetime of the two investment objects differs widely. Considering the ten years lifetime of investment object A, in contrast to only three years lifetime of investment object B, the decision-maker might invest in object A, since the accumulated profit of investment object A is superior to object B.
The two investment appraisal methods comparing costs and benefits are similar to each other, which is the reason for describing them together in this subchapter. As the name already indicates, the focus of the cost comparison method is on the expected costs of the investment objects. Based on these cost projections, the investment objects are compared to each other. Hence, the relative advantageousness can be concluded from the investment object with the lowest amount of costs. Nonetheless, the absolute advantageousness can only be determined in case of replacement or rationalisation investments when comparing the business-as-usual scenario (i.e. opportunity costs of not investing) with the costs of investing into the investment object. (Götze et al., 2008)
The considered expenses comprise operating costs (e.g. for personnel expenses, costs for raw materials, energy, repair and maintenance) as well as financial costs (e.g. depreciation, interest and taxes). The method does not differentiate between fixed and variable costs since all cost accounts of an investment object are accumulated. (Poggensee, 2011)
The cost comparison method bases on the assumption that the revenues and production capacities of the competing investment objects are equal. Since variable costs depend on the planned production capacity, which might be subject to frequent changes, the cost comparison method calculates with the average costs. (Götze et al., 2008) Hence, the cost comparison method ignores the different points of time on which costs and benefits might occur, which therefore classifies as static investment appraisal.
The basic assumptions of similar production capacities and revenue amounts of competing investment objects as well as the ignorance of the time value of money are major points of criticism. Hence, the calculated amounts of costs provide a low likelihood to occur in reality after the investment object has been realised. (Poggensee, 2011)
The benefit comparison method compares the profits of competing investment objects. Hence, the amount of costs as result of the cost comparison method is deducted from the projected revenues of the investment object. Besides this difference, the same assumptions (i.e. identical production capacities and average of variable costs) are applied within the benefit comparison method, concluding the same criticism. (Götze et al., 2008)
With regard to the absolute advantageousness, the investment object should be realised if the profitability is greater than zero. When comparing several investment objects to each other, the relative advantageousness is determined for the investment object with the highest profitability. (ibid.)
The financial ratio Return on Investment (ROI) determines the profitability of an investment object by calculating the relation of profit and invested capital. The result of the ROI ratio is expressed in a percentage. (Poggensee, 2011)
The ROI ratio is mostly applied on company-level to serve as an indicator of the profitability of the whole company. In this case, the literature refers to the ROI as a profitability ratio pyramid since the nominator and denominator are composed by ratios as well. (Lachnit and Müller, 2012) However, when applied on an investment object, the composition of the ratio is less complex. The ROI, which is also referred to as Accounting Rate of Return (ARR), is determined by the average profit divided by the average invested capital in an investment object (see formula below). While the profit is calculated by the difference between cash inflows and cash outflows over the lifetime of an investment object, the invested capital represents the value necessary to acquire the investment object. (Zimmerman, 2011) Thus, the formula for the ROI can be displayed as follows:
Equation 1: Return on Investment formula for capital investment objects
The expression of the ROI as a percentage enables a conclusion about the efficiency of an investment. If ROI > 0%, the result implicates that the investment is amortised, even without knowing the exact point of time when the investment object amortises. Nevertheless, the decision-maker would decide to invest, since the investment is able to add value to the company’s capital anyway.
When comparing the ROI of several investment objects the investment object with the highest percentage is regarded as the most advantageous. Nonetheless, if there is a minimum percentage value defined for the ROI in companies (e.g. requiring a higher ROI than the costs of capital or the market-based interest rate), the decision-maker might tend towards underinvestment since investment alternatives might not meet the minimum required return rate, especially in high interest market environments.
In contrast to the payback period, the ROI is able to consider the lifetime of an investment object. However, the expected profit in the nominator is calculated by averaging the expected cash inflows and cash outflows of the investment object across its lifetime. Hence, the ROI ignores the fact that an investment object’s profitability might vary over its lifetime. Just as the payback period, the ROI does not consider the time value of money and thus, is referred to as static investment appraisal method.
The Net Present Value (NPV) considers the time value of money and therefore classifies as dynamic investment appraisal method. From the date of investment, future expected cash inflows and outflows are discounted or compounded via an interest factor to transfer these cash flows to the same point of time (mostly present time as with the NPV). The discounted cash outflows are subtracted from the cash inflows to calculate the net present value. Hence, the result of the NPV calculation is expressed in absolute monetary value. (Poggensee, 2011)
Figure 11 illustrates the calculation of the NPV:
Figure 11: Illustration of the Net Present Value calculation
Source: Based on Prätsch et al., 2012:347
In case NPV > 0, the decision-maker would decide to invest since the investment object is able to add value to the company. In addition, the investment decision is perceived as less risky since the NPV tries to sketch reality by considering the time value of money in form of the discount factor. Furthermore, the cash flows of the whole lifetime of the investment object are taken into consideration.
However, the decision-maker might tend to overinvest when deciding to invest in each investment object with a positive NPV. That is why the NPV does not reveal any information about the relation between the investment need and the generated profit such as the ROI. Nevertheless, the decision-maker is able to compare several investment objects with the help of the NPV. In this case, the investment object with the highest NPV is regarded as the most profitable over its lifetime.
The Compound Value method (CV) is similar to the NPV. Both methods are classified as dynamic investment appraisal methods by recognising the time value of money. Nonetheless, the biggest difference between these two methods is the point of time future cash flows are transferred to. While the NPV calculates the added value of future cash flows at the starting point of the investment, the CV focuses on the end point of the investment object’s lifetime. While the NPV therefore makes use of a discount factor, the element transferring cash flows to the end point of the investment object’s lifetime is the compound factor. Nevertheless, both factors base on an interest rate which is mostly based on the weighted average cost of capital or market-based interest rates. (Poggensee, 2011; Götze et al., 2008)
The underlying decision criterion with the CV is the same as with the NPV. Hence, absolute advantageousness is given with an investment object showing a CV > 0 while relative advantageousness is assigned to the investment object with the highest CV.
The following figure illustrates the calculation of the CV:
Figure 12: Illustration of the Compound Value calculation
Source: Based on Prätsch et al., 2012:344
To derive the relative advantageousness of several investment objects, the investment object with the highest IRR is preferred. However, in case of no competing investment objects, the decision-maker would decide to invest if the IRR is higher than the costs of capital or the market-based interest rate. This decision is made on the premise that more value can be added to the company’s value by the investment object than with a financial investment on the capital market. (Poggensee, 2011)
The calculation of the IRR is complicated since it is mostly derived by trial-and-error. Furthermore, the IRR leads to unrealistic return rates in some constellations (Zimmerman, 2011). Investment objects with cash flows changing from positive cash flows in one year to negative cash flows in the concluding year even reveal more than one IRR. In this case, it is difficult for the management accounting professional to determine the correct value for the IRR as a basis for decision-making.
The discussed methods within the previous subchapters can either be classified as a static or a dynamic investment appraisal method and support single quantitative strategic goals. However, in case of multiple quantitative strategic goals or in case of qualitative goals, these investment appraisal methods do not offer a helpful result (compare Figure 10).
Hence, the corresponding investment appraisal methods in these cases must be derived from the group of Multiple Attribute Decision-Making (MADM) methods. The most popular method of this group is the Utility Value Analysis which is therefore in the scope of this thesis (Götze et al., 2008).
The Utility Value Analysis (UVA) intends to calculate a value that consists of a weighted sum of several sub-goals. When conducting the UVA, the first step is to determine the sub-goals under consideration. These sub-goals might comprise various quantitative goals (e.g. NPV, ROI, IRR, etc.), a combination of quantitative and qualitative goals or solely qualitative goals. The second step within the Utility Value Analysis assigns weightings to the sub-goals. Each sub-goal is assigned with a relative importance (step two) so that the sum of all weighted sub-goals is equal to 1 or 100. (Poggensee, 2011; Götze et al., 2008)
Afterwards, the third step comprises a judgement of how far each investment object meets each sub-goal. This judgement can either be conducted on basis of a nominal, ordinal or cardinal scale. These assigned values of the expert judgements are multiplied with the weightings of the sub-goals in the following step (step four) to derive a utility value for each sub-goal. (ibid.)
Finally, the utility values of the sub-goals are added to calculate the overall utility value of each investment object (step five). Hence, unfavourable results of one sub-goal can be compensated by favourable results of other sub-goals unless no minimum value was previously determined functioning as a threshold value. (ibid.)
A generic example of the underlying calculations of a UVA can be retrieved from the following table:
Figure 13: Generic example of Utility Value Analysis
Regarding the investment decision, the absolute advantageousness is given if an investment object is above a targeted utility value. Alternatively, the relative advantageousness is given for the investment object with the highest utility value compared to its competing alternatives. (Götze et al., 2008)
As already indicated the UVA experiences increased popularity within business practice. One reason is the fact that the result in form of a single-score value is easily comprehensible. In addition, the method offers a structured procedure and its underlying simple calculations can be conducted also by non-financial experts. (ibid.)
However, the UVA also faces criticism which mainly focuses on the subjective judgements of the person conducting the method. Besides these judgements, the determination of sub-goals and assignment of weightings to these sub-goals represent subjective steps. The steps of weighting the sub-goals as well as the judgement of the utility values require extensive timely effort. Furthermore, the resulting utility values are accompanied with uncertainty, which is why sensitivity analyses should be conducted to assess the degree of deviation of results, in case assumptions, weightings or judgements change. (Poggensee, 2011)
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