The use of capital budgeting techniques: an outlook from Italy

Abstract

Capital budgeting is one of the most important areas of financial management. Different techniques are used to evaluate capital budgeting projects: the Payback Period (PP), the Net Present Value (NPV) and the Internal Rate of Return (IRR). Graham and Harvey (2002) highlight that financial managers favour methods such as the IRR or non–discounted Payback Period (PP). The results of this research revealed that PP, followed by NPV, is the most used method. The more complex methods are most favoured by the large enterprises. The principal weakness of the evaluation process is the definition of cost of capital: approximately 70% of the enterprises considered use non–quantitative techniques to consider risk. This study provides those evaluating investment projects or conceiving capital budgeting manuals or policies with knowledge about common pitfalls that, if acted upon, could improve decision making. This study is exploratory research and the results represent a basis for further research.