Abstract
This article investigates the application of capital budgeting techniques and the incorporation of risk into the capital budgeting process among a sample of South African industrial firms listed on the JSE Securities Exchange for at least ten years. Previous international and local research on this topic indicated a preference for the internal rate of return (IRR) as a capital budgeting method over the net present value (NPV), and that risk incorporation was relatively rarely incorporated into the capital budgeting process. The results of this study indicate that the NPV is just as popular as, and sometimes more so than, the IRR. Furthermore, compared to previous studies, risk is incorporated into evaluating capital budgeting projects more often. Sensitivity analysis is the most popular method, but adjustments to the cash flows and discount rate are becoming more popular. During the last decade the use of non-financial criteria to accept or reject a project has also increased in South Africa.
Highlights
The importance of capital budgeting for capital formation and the growth of a country’s gross domestic product is undoubtedly one of the most important topics in economics today
The purpose of this paper is to present evidence on capital budgeting practices based on a survey of a number of carefully selected companies listed on the JSE Securities Exchange (JSE)
Gitman and Forrester (1977) found that 71 per cent of their respondents gave explicit consideration to risk. They argued that these results were confirmed by a study by Fremgen in 1973 in which 67 per cent of Fremgen’s respondents incorporated risk in the evaluation of their capital budgeting projects. It seems that empirical studies covering several decades, indicate that for a long time the net present value (NPV) trailed the internal rate of return (IRR) as preferred capital budgeting method and the incorporation of risk in the capital budgeting process varies both in the methods applied as well as in the rate of application of these methods
Summary
The data was collected by means of personal interviews with the person responsible for the capital budgeting process at each of the identified companies. 41 usable responses were gleaned from the 67 sample companies, which were used in the empirical analysis
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