Use Of Capital Budgeting Techniques Research Articles

The evolution of the application of capital budgeting techniques in enterprises

This study examines the evolution of the application of capital budgeting techniques. Previous studies mostly used cross-sectional inquiries to understand the capital budgeting practices of firms. Only a few researchers have undertaken longitudinal studies to generalise the findings of the individual cross-sectional studies to the wider population and to identify the emerging trends in the use of capital budgeting techniques (CBTs). This longitudinal study surveys 83 studies of capital budgeting practices across firms in India, South Africa, the United Kingdom (UK) and the United States of America (USA) for the period from 1966 to 2016. The findings show that six capital budgeting techniques, namely, the net present value (NPV), the internal rate of return (IRR), the payback period (PBP), the accounting rate of return (ARR), the return on investment (ROI) and the real option valuation (ROV), are the most popular methods for evaluating capital investments. Of these techniques, the ROV is the least used, and a general lack of familiarity with this technique and its complexity are the most commonly cited reasons for not using it. Another method that is used less than the first four techniques is the ROI. However, this technique is of growing significance and is mainly used in the UK, followed by the USA, South Africa, and India. Firms in the USA and UK have increased their use of the IRR as a primary method for evaluating capital projects and have retained the PBP as an ancillary technique to strengthen the available information when evaluating capital projects. Firms in India and South Africa are increasingly excluding both the PBP and ARR methods and are increasingly using the NPV when evaluating capital investments. Although this development is in line with the theory, it limits the scope of the available information when evaluating capital projects.

Financial Management Practices, Firm Growth and Profitability of Small and Medium Scale Enterprises (SMEs)

The study examined financial management practices using four components: working capital management practices, capital structure management, accounting information and financial reporting practice, and the use of capital budgeting techniques and fixed assets management. Performance of SMEs was examined from the context of profitability measured by Return on Assets and of growth. The study sampled 100 SMEs from Accra with data collected through the administration of a questionnaire. Data were analysed using descriptive statistics and Pearson correlation analysis. The results of the descriptive statistics revealed that working capital management practices had the highest mean score, followed by accounting information and financial reporting practices, capital structure management and finally, the use of capital budgeting techniques and fixed assets management, in that order. The Pearson correlation analysis showed a positive association between the four components of financial management practices and between SMEs profitability and growth. The results emphasize the need for SMEs to improve on their financial management practice to improve the profitability and growth of these firms. It is recommended that the use of capital budgeting techniques be improved, as this area of financial management, even though it impacts positively on the performance of SMEs had the least score. Most importantly, the managers of SMEs should use discounted cash flow techniques to evaluate investment and projects before committing the resources of the company. SMEs are encouraged to adopt IFRS for SMEs to enhance their financial reporting practices. This will also improve their decision making and access to capital which will allow these SMEs to expand.

Financial Management Practices: An Exploratory Study of Capital Budgeting Techniques in the Caribbean Region.

This paper analyzes the use of capital budgeting techniques of firms in the Caribbean in countries such as Barbados, Bahamas, Jamaica and Trinidad and Tobago using data obtained from a survey among publicly and non-publicly listed firms in the region. The main aims of the study are to analyze the extent to which Caribbean firms have adopted sophisticated modern financial management techniques to explain any inter-firm and or inter-country differences.

The use of capital budgeting techniques: an outlook from Italy

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.

The Use of Capital Budgeting Techniques in Evaluating Investment Projects : An Applied Study on the Palestinian Corporations Working in Gaza Strip

تهدف هذه الدراسة إلى التعرف على مدى استخدام أساليب الموازنة الرأسمالية في اختيار المشروعات الاستثمارية والمعوقات (إن وجدت) التي تحد من استخدام أساليب الموازنة الرأسمالية في شركات المساهمة العامة بقطاع غزة. ولتحقيق هذا الهدف, استخدمت الدراسة المنهج الوصفي التحليلي، ولقد اشتمل مجتمع الدراسة على ثمان عشرة شركة مساهمة عامة وهي جميع الشركات المساهمة المسجلة في وزارة الاقتصاد الفلسطينية بقطاع غزة. وتم توزيع عدد خمسين استبانه على العاملين بأقسام الاستثمار أو الشؤون المالية بالشركات محل الدراسة, وبلغت نسبة الاسترداد 80%, واستخدم برنامج SPSSالإحصائي بغرض تحليل النتائج. وخلصت الدراسة إلى أن الشركات المساهمة العامة بقطاع غزة تستخدم أساليب الموازنة الرأسمالية عند اختيار المشروعات الاستثمارية , وان نسبة استخدام هذه الأساليب تتراوح بين 61 إلى 80%, بالإضافة إلى أن مؤشر الربحية هو الأسلوب الأكثر استخداما في هذه الشركات , في حين أن أسلوب صافي القيمة الحالية هو الأسلوب الأقل استخداما. هذا وقد خلصت الدراسة إلى أن هذه الشركات لا تستخدم متوسط التكلفة المرجحة لرأس المال سواء معدل أو غير معدل في تحديد معدل الخصم اللازم لاستخدام بعض الأساليب. كما وجدت الدراسة أن الشركات تأخذ بعين الاعتبار العديد من العوامل قبل اعتماد أحد أساليب الموازنة الرأسمالية كأساس للمفاضلة بين المشروعات الاستثمارية وأهم هذه العوامل هو مدى توفر البيانات والمعلومات اللازمة لاستخدام هذا الأسلوب, كما أظهرت الدراسة أن هذه الشركات تفضل الأساليب التي تركز على التدفق النقدي وتلك الأساليب التي تقتنع بها إدارة المنشأة. من ناحية أخرى, أظهرت الدراسة وجود عدد من المعوقات التي تقوض استخدام أساليب الموازنة الرأسمالية في شركات المساهمة العامة بقطاع غزة أهمها عدم توفر البيانات والمعلومات اللازمة لاستخدام هذه الأساليب بالإضافة إلى عدم التأكد المصاحب لاستخدام أساليب الموازنة الرأسمالية في حين أن وجود مؤسسات خارجية لإدارة الاستثمارات هو العائق الأقل تأثيرا على استخدام أساليب الموازنة الرأسمالية في هذه الشركات. ولقد اقترحت الدراسة مجموعة من التوصيات أهمها ضرورة التوسع في استخدام أسلوب صافي القيمة الحالية بشكل خاص واستخدامه كأسلوب أساسي لتقييم المشروعات الاستثمارية لما له من تفوق نوعي على باقي الأساليب خصوصا أنه يقيس الزيادة في رأس مال المساهمين.

Capital Budgeting Techniques Used by Small Manufacturing Companies

Small companies account for 40% of Australian jobs and yet most of the studies on capital budgeting techniques have been focused on large firms. A mistake in their capital budgeting process could lead to disastrous consequences as they do not have the financial clout to recover from them. The purpose of the paper is to investigate where small manufacturing companies in Australia stand in regard to the use of capital budgeting techniques and risk analysis. The research concludes that while there is an indication of usage of the Payback Period with Discounted Cash Flow (DCF) techniques, there is a need for more frequent usage of risk analysis as well as management sciences which is found lacking in the capital budgeting process of small companies.

Capital Budgeting for Information Systems Investments – Evidence from Kenya

This article explores the use of capital budgeting techniques to appraise Information Systems (IS) investments in commercial banks in Kenya. Results of the survey of 25 banks show that the level of usage of simple ratio-based techniques such as cost benefit analysis (CBA), payback period and return on investment (ROI) to appraise IS investments is very high compared to the use of discounted cash flow (DCF) techniques such as net present value (NPV) and internal rate of return (IRR). These findings confirm the existence of a gap between theoretically correct investment appraisal practices that lay emphasis on the use of DCF techniques, and practice.

Capital Budgeting Practices and Economic Development: A Comparative Study of Companies in Western Europe and West Africa

Over the years, efforts have been made to increase the developmental strides of African countries. Many projects move from donor countries like the United Kingdom and the United State into Africa to help improve the lives of the people. However, these efforts have not been able to redeem Africa from abject poverty and indebtedness to the West. Various projects that are targeted towards the reduction of poverty are normally completed with no changes in the lives of the people. These projects, in my opinion, have not been scrutinised to assess their capabilities of meeting some stated target. Capital budgeting practices are some of the vital inputs in the decision-making process of embarking on investment projects. A very good analysis, scrutiny, implementation and monitoring of such projects could yield the expected results for the stakeholders (people of the country). According to Dayananda et al (2002), the capital budgeting practices are used to make investment decisions so as to increase shareholders value. Capital budgeting is primarily concerned with sizable investments in long-term assets, Brealey & Myers (2003). These assets may be tangible items such as property, plant or equipment or intangible ones such as new technology, patents or trademarks. Investments in processes such as research, design, development and testing – through which new technology and new products are created – may also be viewed as investments in intangible assets (IBID). Dayananda et al (2002), argued that irrespective of whether the investments are in tangible or intangible assets, a capital investment project can be distinguished from recurrent expenditures by two features. One is that such projects are significantly large. The other is that they are generally long-lived projects with their benefits or cash flows spreading over many years. Sizable, long-term investments in tangible or intangible assets have long-term consequences (IBID). This implies that today’s investment will determine the overall corporate strategic position over many years. These capital investments also have a considerable impact on the future cash flows of the organization and the risk associated with those cash flows. Capital budgeting decisions thus have a long-range impact on the strategic performance of the organization and are also critical to its success or failure. This paper compares the use of capital budgeting techniques by companies in Europe and West Africa, using data obtained from a survey between 225 European and 120 West African companies. The main aim is to analyse the use of capital budgeting techniques by companies in both economic blocs from a comparative perspective to see whether economic development matters in the choice of which technique to use. The empirical analysis provides evidence that European CFOs on average use more sophisticated capital budgeting techniques than their counterparts in West African. At the same time, however, the results suggest that the differences between European and West African companies is smaller than might have been expected based upon the differences in the level of economic development between both economic blocs. At least, this is evident with respect to the use of methods of estimating the cost of capital and the use of CAPM as the method of estimating the cost of equity.

Investment appraisal practices: A comparative study of conventional and Islamic financial institutions

Abstract This paper compares the use of capital budgeting techniques of conventional and Islamic financial institutions, using data obtained from a survey of 105 conventional and Islamic financial institutions. Our main aim is to analyze the use of capital budgeting and risk techniques by the two types of financial institutions from a comparative perspective to see whether prohibition of riba makes a difference. Standard difference-of-means tests of the mean scores methods were used to test the hypotheses of the study. The results reveal a number of important conclusions. First, discounted cash flow techniques are found to be more widely used by financial institutions, and among those techniques internal rate of return is the most common. Second, Islamic financial institutions are found to adopt traditional methods that do not comply with the principles of Islamic Sharia'a. Third, a huge gap is found between the theory base of Islamic institutions and some of the practices of those institutions. Fourth, firms' characteristics, such as size, listing status, sources of revenue and government ownership, have some impact on their decisions to adopt capital budgeting criteria, methods of estimating costs of capital and risk. Finally, the decisions to select particular capital budgeting techniques, cost of capital estimation methods, and risk assessments are partly related to the characteristics of the chief financial officers.

Reducing Rents from Energy Technology Adoption Programs by Exploiting Observable Information

In this paper, we study how regulators may improve upon the efficiency of their energy technology adoption programs by exploiting readily observable information to limit rent extraction by firms. Using panel data on 862 investment decisions in the Netherlands, we find that rent extraction is closely linked not only to technology characteristics, but also to the firm's capital budgetting technique. In particular, we find that firms are more likely to extract rent when either the technology's pay-back period or its required investment is lower, but less likely if they do not use a formal capital budgeting technique. Standard firm characteristics, such as size and sector, correlate with firms' use of capital budgeting techniques, thereby partly resolving the regulator's asymmetric information problem.

Capital Budgeting and Political Risk: Empirical Evidence

AbstractThis paper surveys and investigates Swedish firms' use of capital budgeting techniques for foreign direct investments. We document that the use of the theoretically correct net present value method decreases with the political risk in the host country, and that the use of the Payback method increases with the political risk. We conclude that in the presence of capital market imperfections, unsystematic and country‐specific political risks are important. Because these risks are difficult to estimate (rendering high deliberation costs) managers are inclined to use simple rules of thumb for their capital budgeting decisions. Our results can partly explain why surveys find that alternative methods such as the Payback method are frequently used despite their theoretical drawbacks.

Capital Budgeting and Escalation of Commitment

This study uses experimental methods to explore whether the use of capital budgeting techniques affects escalation of commitment, or the tendency of decision makers to continue to commit resources to a project after receiving negative feedback. Findings indicate that the application of capital budgeting techniques can reduce, but does not eliminate, escalation of commitment. This result demonstrates the pervasiveness of the escalation of commitment phenomenon as well as an avenue for its reduction.

Capital budgeting practices: A comparative study of the Netherlands and China

This paper compares the use of capital budgeting techniques of Dutch and Chinese firms, using data obtained from a survey among 250 Dutch and 300 Chinese companies. Our main aim is to analyse the use of capital budgeting techniques by companies in both countries from a comparative perspective to see whether economic development matters. The empirical analysis provides evidence that Dutch Chief Financial Officers (CFOs) on average use more sophisticated capital budgeting techniques than Chinese CFOs do. At the same, however, our results suggest that the difference between Dutch and Chinese firms is smaller than might have been expected based upon the differences in the level of economic development between both countries, at least with respect to the use of methods of estimating the cost of capital and the use of CAPM as the method of estimating the cost of equity.

Capital Budgeting and Political Risk: Empirical Evidence

This paper surveys and investigates Swedish firms' use of capital budgeting techniques for Foreign Direct Investments. We document that the use of the theoretically correct net present value (NPV) method decreases with the political risk in the host country, and that the use of the Payback method increases with the political risk. We conclude that in the presence of capital market imperfections, unsystematic and country-specific political risks may be important and as they are difficult to estimate (rendering high deliberation costs), managers may be inclined to use simple rules of thumb. This type of behavior might partly explain why surveys find that alternative methods such as the Payback method are frequently used despite their theoretical drawbacks.

Capital Budgeting Practices: A Comparative Study of The Netherlands and China

This paper compares the use of capital budgeting techniques of Dutch and Chinese firms, using data obtained from a survey among 250 Dutch and 300 Chinese companies. Our main aim is to analyse the use of capital budgeting techniques by companies in both countries from a comparative perspective to see whether economic development matters. The empirical analysis provides evidence that Dutch CFOs on average use more sophisticated capital budgeting techniques than Chinese CFOs do. At the same, however, our results suggest that the difference between Dutch and Chinese firms is smaller than might have been expected based upon the differences in the level of economic development between both countries, at least with respect to the use of methods of estimating the cost of capital and the use of CAPM as the method of estimating the cost of equity.

Capital Budgeting Practices: A Survey in the Firms in Cyprus

Introduction Cyprus is a small country with some special characteristics: first, its geographic position as it stands between east and west; and second, its eventual joining to the European Community. According to the Union of Industrial and Employers' Confederations of Europe (UNICE), Cyprus is expected to be ready to confront competition and pressures in the common market, since it is an important place of economic activities among Europe, North Africa, and the Middle East. To meet this competition and pressures successfully, Cyprus's businesses need imperatively today more than ever an increase in the volume of their investments and a readjustment of their investment policy. The need for a readjustment of their investment policy is the result of important differences that exist between the capital budgeting practices in Cyprus and those used in the United States (Cooper and Petry 1994; Gitman and Mercurio 1982; Kim and Farragher 1981; Schall 1978; Fama 1977; Fregren 1973; Klammer 1972) and other European countries. Specifically, most American and European firms use scientific evaluation methods (Vogt 1994; Pinches 1982; Perty 1975), whereas Cypriot firms use empirical ones. This may be explained by the fact that Cypriot entrepreneurs are reluctant to use new evaluation methods since they rely basically on the past and their experience. The purpose of this paper is to investigate (1) the methods used by the Cyprus companies to evaluate investments (the ones that are materialized); and (2) the approach adopted to handle important estimation problems inherent to the use of these methods, such as the definition and estimation of the cost of capital and the incorporation of risk analysis in the evaluation methods used (Woods and Randall 1989). More specifically, the second section of the paper focuses on the review of the literature associated with the use of capital budgeting techniques in practice. The third section explains the methodology used in the implementation of the survey. The fourth section gives a short summary of the profile of the sample companies. The fifth section presents and analyzes the results of the survey, and the last section of the paper presents conclusions and provides suggestions for further research. Review of Literature Gitman and Forrester (1977)'s research, based on a survey of 268 U.S. firms, found that the internal rate of return was the most popular technique at that time. This finding was supported by a similar survey conducted by Scott and Petty (1984) for large U.S. firms. The findings of this research were that the companies prefer the IRR method, with the payback period being a supplementary tool. As far as the discount rate used, they found that the primary one is a management-determined target rate of return followed by the weighted cost of capital. Academicians, as we all know, prefer the net present value (NPV) method for capital budgeting decisions. Practitioners, on the other hand, prefer the internal rate of return (IRR) method, as several other studies have revealed. For example, the study of Pan, Nichols, and Joy (1977) presented some evidence regarding the current state of the art of business sales forecasting practices. McDaniel, McCarty, and Jessell (1988), developed an alternative yield-based capital budgeting technique, the marginal return on invested capital (MRIC). This technique, the authors proved, can be applied more generally than other yield-based methods used as substitutes for the NPV technique. Porter (1992) stated that U.S. companies use hurdle rates that are higher than their estimated cost of capital for the evaluation of investment projects. Harris and Raviv (1996) studied the capital allocation process within firms. They constructed a model that incorporated managerial incentive problems and asymmetric information and showed that in an optimal capital budgeting process, the top manager specifies an initial limit for capital spending that can be upgraded after further examinations and audits. …

How Planning and Capital Budgeting Improve SME Performance

This paper focuses on the use of strategic planning among small and medium sized enterprises (SMEs) in the UK manufacturing sector. It analyses the relationship between the intensity of strategic planning, business objectives, perceived performance, changes in the business environment and the use of capital budgeting techniques. Capital budgeting is of particular interest as an area of investigation, and is one which has seldom featured in previous studies of strategic planning behaviour. These issues were investigated via a survey of UK manufacturing SMEs carried out in the winter of 1996/97. The key results suggest that SMEs incorporate a range of objectives into their strategic planning process, with profit improvement perceived to be the most important objective, followed by sales growth. SMEs engaged in detailed strategic planning are more likely to use formal capital budgeting techniques, including the net present value method, which is consistent with maximising the companys' value. Perceived profitability and success in achieving organisational objectives were positively associated with planning detail, suggesting that strategic planning is a key component improving performance. Planning detail was also associated with a significantly higher level of perceived change in the business environment.

How planning and capital budgeting improve SME performance

This paper focuses on the use of strategic planning among small and medium sized enterprises (SMEs) in the UK manufacturing sector. It analyses the relationship between the intensity of strategic planning, business objectives, perceived performance, changes in the business environment and the use of capital budgeting techniques. Capital budgeting is of particular interest as an area of investigation, and is one which has seldom featured in previous studies of strategic planning behaviour. These issues were investigated via a survey of UK manufacturing SMEs carried out in the winter of 1996/97. The key results suggest that SMEs incorporate a range of objectives into their strategic planning process, with profit improvement perceived to be the most important objective, followed by sales growth. SMEs engaged in detailed strategic planning are more likely to use formal capital budgeting techniques, including the net present value method, which is consistent with maximising the companys' value. Perceived profitability and success in achieving organisational objectives were positively associated with planning detail, suggesting that strategic planning is a key component improving performance. Planning detail was also associated with a significantly higher level of perceived change in the business environment.

UK capital budgeting practices: some additional survey evidence

Probably more surveys have been undertaken on the use of capital budgeting techniques than on any other accounting and finance topic. Despite the many surveys a number of issues remain unresolved. The surveys have consisted of a sample of either very large or very small companies and observations relating to the impact of company size have been derived from comparing the responses from different surveys undertaken at different points in time. The aim of this paper is to provide additional empirical evidence relating to some of the unresolved issues and to examine the impact of company size on the use of financial appraisal techniques. In particular, the paper concentrates on the treatment of inflation, the appraisal of advanced manufacturing technologies and examines whether the empirical evidence supports the claim that many companies use excessive discount rates.

Hotel Renovations: A Capital Budgeting Problem

ABSTRACT Recent studies have shown that the use of capital budgeting techniques by major hotel chains are not as prevalent as in other service industries. The use of Discounted Cash Flow techniques by major hotel chains is even less prevalent when companies contemplate large scale renovation projects. The development and use of a theoretically correct discounted cash flow model is necessary to assist financial decisions concerning hotel renovation projects. A proposed model for Hotel Renovation Projects is discussed on a conceptual basis.