A Survey of Capital Budgeting

Topics: Net present value, Capital budgeting, Internal rate of return Pages: 71 (10330 words) Published: March 10, 2011
Satish Verma, Sanjeev Gupta and Roopali Batra
The present study aims to unveil the status of capital budgeting in India particularly after the advent of full-fledged globalisation and in the era of cutthroat competition, where companies are being exposed to various degrees of risk. For the above objective a comprehensive primary survey was conducted of 30 CFOs/CEOs of manufacturing companies in India, so as to find out which capital budgeting techniques is more preferred, discounted or non-discounted. The study also aims at examining the capital budgeting methods used for incorporating risk in investment proposals. It further endeavours to evaluate the impact of different factors or variables on the selection of a particular capital budgeting technique. For example, it was investigated that whether there exists any relationship between a size of company’s capital budget and the method of capital budgeting adopted by it. Similarly it was discovered that is there any systematic relationship between different company related factors like age of a company, CEO education/qualification and the capital budgeting method adopted by it.

Key Words: Capital Budgeting, Discounted Cash Flow, Non Discounted Cash Flow, NPV, IRR, Payback Period, ARR, Discount Rate, Cost of Capital, Risk
Firms invest in long term assets in anticipation of
an expected flow of benefits over the lifetime of
the capital asset. It involves sacrifice of a certain
amount of present resources in exchange for a future
return and an arbitrage over the time that involves risk.
For evaluating these investments or projects, various
capital budgeting techniques or methods are available.
While certain companies still prefer old non-discounted
less sophisticated techniques, others have moved
towards more sophisticated discounted cash flow (DCF)
techniques. The traditional non-discounted techniques
though used rigorously initially, are today mostly applied
as a supplementary method in combination with the
discounted cash flow techniques.
The earlier studies conducted in India emphasised
mainly on the capital budgeting practices in times
when the level of competition and the entry and exit of
multinational companies in India was restricted. In the
post liberalisation era, after the government relaxed the
entry and exit rules for foreign companies in India and
gave a vent to full fledged globalisation, no major Indian
study except that by Anand (2002) has been conducted.
However, even after this time a number of changes
further took place in the Indian economic environment. The government was opening up in other sectors like power,
insurance, banking and allowing private participation in
many new areas. As a result of these measures initiated by
the government, in the years 2005-06 the economy grew
at a steady pace. There was a spurt in foreign investment
through Foreign Institutional Investors (FIIs) and the
rupee strengthened against the dollar. Unprecedented
changes took place in various financial sectors like
banking, insurance etc and a number of global mergers
took place with MNCs entering in each and every sphere
of business. There was a boom in the foreign trade with
increasing exports and foreign reserves resulting in VISION—The Journal of Business Perspective l Vol. 13 l No. 3 l July–September 2009 2 l Verma, Gupta and Batra
mounting Indian stock markets. By the end of the year
2007, the economy and its stock market reached at its
However, there was a sudden slowdown of Indian
markets after 2007 (January, 2008). The year 2008 was
indeed very turbulent and unstable for Indian corporate
sector, under the adverse impact of gloomy and miserable
foreign markets. As a consequence, Indian stock markets
crashed down, dollar became stronger resulting in
expensive imports and reducing...
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