Evaluating various methods of capital budgeting

i
A
COMPREHENSIVE PROJECT REPORT
ON
“EVALUATING VARIOUS METHODS OF CAPITAL
BUDGETING”
SUBMITTED TO
INDUS INSTITUTE OF MANAGEMENT STUDIES
IN PARTIAL FULLFILLMENT OF THE
REQUIREMENT OF THE AWARD FOR THE DEGREE OF
MASTER OF BUSINESS ADMINISTRATION
UNDER THE GUIDENCE OF
Dr. KINJAL JETHWANI
SUBMITTED BY
JASH PANDIT – IU1555550021
INDUS INSTITUTE OF MANAGEMENT STUDIES
M.B.A PROGRAMME
AHMEDABAD
MAY – 2017

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PREFACE
This project provides an opportunity to demonstrate application of my knowledge,
skill and competencies required during the financial session. This project helps me to
devote my skill to analyze the problem to suggest alternative solutions and to evaluate
them.
I have worked on the topic is “Evaluating various methods of Capital Budgeting”.
I have put my level best to prepare my project an error free project every effort has
been made to offer the most authenticate position with accuracy.

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CERTIFICATE
To whom it may concern
This is to certify that Mr. JASH K. PANDIT Enrolment No. IU1555550021 of
MBA is Bonafide regular student of Indus Institute of Management Studies, Indus
University Ahmedabad for the session 2015-17.
They have completed the functional project report entitled “Evaluating various
methods of capital budgeting” as a part fulfillment for the award of MBA degree
under Indus University, Ahmedabad.
I find the research report is up to standard and original one.
(Dr. KINJAL JETHWANI)
Faculty Guide

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ACKNOWLEDGEMENT
I would like to express my profound gratitude to all those who have been instrumental
in the preparation of this report which has been prepared in partial fulfillment of
Comprehensive Project in the Semester IV of an MBA programme.
This project could only be completed with the assistance of Dr. Kinjal Jethwani
having being a valued guide.
Finally i would like to thank my Parents, Family, Friends and God almighty for their
unending inspiration and encouragement.
Place: Ahmedabad Jash K.Pandit
(IU1555550021)
Date:

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DECLARATION
I, Jash K. Pandit, hereby declare that the report for “Comprehensive Project” entitled
“Evaluating various methods of Capital Budgeting” is the result of my own work
and my indebtness to other work publications, references, if any, have been duly
acknowledged.
Place : Ahmedabad Jash K. Pandit
(IU1555550021)
Date:

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EXECUTIVE SUMMARY
Capital budgeting decisions are very important for financial managers since they
determine the choice of investment projects that will affect company value. The
adoption of the appropriate capital budgeting tools provides managers with both the
processes and techniques required to make decisions that will enhance the
organization‟s resource base while improving its ability to serve its members and
evaluate effectiveness of its investments.
On the capital budgeting technique, the study found out that all the proposed capital
budgeting techniques were utilized in the organization. The most utilized capital
budgeting method was internal rate of return followed by net present value technique.
Profitability index technique was third while Present- Value technique was fourth.
Other techniques utilized included discounted Payback technique,
Accounting/Average Rate-of-Return technique and Modified Internal Rate of Return
(MIRR) technique. For those least utilized, the respondents identified failure to take
into account time value of money as they key reason for not applying some techniques
followed by lack of familiarity with the technique and cumbersome computations
involved.
On the risks in capital budgeting techniques, high inflation affecting interest rates
ranked the greatest risk, other risks such as cash flow not flowing in as anticipated.
Collapse of the investee company, management investing the invested funds in risky
projects, and fluctuating cost of capital used in computations, re encountered only to a
little extent with an average were encountered by the firms.
The study recommends that capital budgeting be a key process in an organization‟s
development plan which needs to be handled with strict care because of the impact it
has on the future of the organization. It recommends that capital budgeting appraisers
collect as much information as possible concerning the investment project, macro-
economic changes that are likely to affect the operating environment so as to come up
with appropriate inflation adjusted cost of capital used in appraising projects. The
study further recommends that capital budgeting process incorporate risk management
officers who would advice the team on ways of minimizing such risks.
The volatility of the global economy, changing business practices, and academic
developmentshave created a need to re-examine Indian corporate capital budgeting
practices. Ourresearch is based on a sample of 77 Indian companies listed on the
Bombay Stock Exchange. Result several that corporate practitioners largely follow
the capital budgeting practices proposed byacademic theory. Discounted cash flow
techniques of net present value and internal rate of returnand risk adjusted sensitivity
analysis are most popular. Weighted average cost of capital as costof capital is most
favoured. Nevertheless, the theory-practice gap remains in adoption of specialized
techniques of real options, modified internal rate of return (MIRR), and simulation.
Non-financialcriteria are also given due consideration in project selection.

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TABLE CONTENT
PREFACE..................................................................................................................................ii
CERTIFICATE.........................................................................................................................iii
ACKNOWLEDGEMENT........................................................................................................iv
DECLARATION.......................................................................................................................v
EXECUTIVE SUMMARY ......................................................................................................vi
1. INTRODUCTION .............................................................................................................1
1.1 Types of Investment decision: .........................................................................................3
1.2 Investment appraisal criteria...........................................................................................5
1.3 Risk and Return Fundamentals .......................................................................................5
1.4 OBJECTIVES OF THE STUDY.....................................................................................6
2. Review of literature............................................................................................................7
3. RESEARCH METHODOLOGY.....................................................................................36
3.1 RESEARCH DESIGN...................................................................................................37
3.2 SOURCESOF DATA ...................................................................................................37
3.3 SCOPE OF THE STUDY..............................................................................................38
3.4 SIGNIFICANCE OF THE STUDY...............................................................................38
3.5 DATA COLLECTION ..................................................................................................40
4. RESULTS AND FINDINGS...........................................................................................58
4.1 Capital budgeting techniques practiced by Indian companies .......................................59
4.2 Capital budgeting techniques preferred by companies distributed according to capital
budget size and sales turnover. ............................................................................................61
4.3 Discount rate/cut off rate used in investment evaluation...............................................62
4.4 Consideration of risk by Indian companies....................................................................63
4.5 Risk adjusted capital budgeting techniquespreferred by Indian companies ..................64
4.6 Non-financial considerations in capital budgeting decisions.........................................64
5. CONCLUSION................................................................................................................66
6. ANNEXURE.......................................................................................................................i
7. BIBLIOGRAPHY...........................................................................................................viii

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List of Table
TABLE-2.1 Snapshot of Literature Review (Foreign Studies)................................................34
TABLE-2.2Snapshot of Literature Review (Indian Studies)...................................................35
Table 3.1Simple PBP and Discounted PBP.............................................................................45
Table 3.2NPV Profile...............................................................................................................55
Table 5.1Key Findings and Conclusions .................................................................................69

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 WHAT IS CAPITAL BUDGETING?
Capital investment decisions that involve the purchase ofItems such as land,
machinery, buildings, or equipment areamong the most important decisions
undertaken by theBusiness manager. These decisions typically involve
theCommitment of large sums of money, and they will affect theBusiness over a
number of years. Furthermore, the funds toPurchase a capital item must be paid out
immediately,Whereas the income or benefits accrue over time.
 USEFULNESS IN FINANCING PROCESSES:
The purpose of an economic profitability analysis is to determineWhether the
investment will contribute to the long runProfits of the business. Although various
techniques canBe used to evaluate alternative investments, including thePayback
period and internal rate of return, the mostCommonly accepted technique is net
present value, otherwiseKnown as “Discounted cash flow”.
1.1 Introduction:
A number of researchers in finance and accounting have examined corporate
capitalbudgeting practices. Many of these articles survey corporate managers and
report thefrequency with which various evaluation methods, such as payback, internal
rate of return(IRR), net present value (NPV), discounted payback, profitability index
(PI), or averagereturn on book value are used. The best known field studies about the
practices ofcorporate finance are Gitman and Forrester‟s (1977) study of Capital
BudgetingTechniques Used by Major U.S. Firms, Porwal‟s (1976) study on Capital
BudgetingTechniques and Profitability and Graham and Harvey‟s (2001) study on
capitalbudgeting, cost of capital, and capital structure. It is believed that the findings
of thisstudy in the context of India are useful to academia and practitioners in learning
howcorporate India operates, developing new theories, and identifying areas where
financetheory is not implemented.What are the capital budgeting tools and techniques
being practiced by the industry andhow popular are they? Do firms use methods that
help to maximize the firm value? Thereview of empirical surveys and studies help to
find answers to these questions.The changes in capital budgeting procedures over the
decades have been welldocumented in prior studies. The research of Canada and
Miller, Fremgen, Gitman andForrester, Kim and Farragher, Stanley Block all indicate
that increasingly sophisticatedcapital budgeting procedures have been put in
practice.However, a generalization that more sophisticated practices take place across
allindustries is subject to investigation and challenge. This consideration is
importantbecause an analyst within a given industry may be intending on following
industry normsbut misled by general observation that relate to the studies cited above.
Just as there aredifferent valuation procedures or financing norms between industries,
there may also bedifferent capital budgeting procedures.Rosenblatt and Jucker (1979)

3
and Scott and Petty (1984) summarize several of thesesurveys. They show that from
1955 to 1978 the use of techniques which recognize thetime value of money (i.e.,
IRR, NPV, PI and discounted payback) by sample firms rosefrom .09 to around .80.
However, many survey authors express surprise that a greaterpercentage of the
respondents did not use techniques which discounted future cash flows.A number of
textbooks have similar concerns.
1.1 Types of Investment decision:
1. Expansion of existing business.
2. Investment in new business.
3. Replacement and modernization
Expansion and Diversification
A company may add capacity to its existing product lines to expand existing
operation. For example, the Company Y may increase its plant capacity to
manufacture more “X”. It is an example of related diversification. A firm may expand
its activities in a new business. Expansion of a new business requires investment in
new products and a new kind of production activity within the firm. If a packing
manufacturing company invest in a new plant and machinery to produce ball bearings,
which the firm has not manufacture before, this represents expansion of new business
or unrelated diversification. Sometimes a company acquires existing firms to expand
its business. In either case, the firm makesinvestment in the expectation of additional
revenue. Investment in existing or new products may also be called as revenue
expansion investment.
Replacement and Modernization
The main objective of modernization and replacement is to improve operating
efficiency and reduce costs. Cost savings will reflect in the increased profits, but the
firm‟s revenue may remain unchanged. Assets become outdated and obsolete with
technological changes. The firm must decide to replace those assets with new assets
that operate more economically. If a Garment company changes from semi automatic
washing equipment to fully automatic washing equipment, it is an example of
modernization and replacement. Replacement decisions help to introduce more
efficient and economical assets and therefore, are also called cost reduction
investments. However, replacement decisions that involve substantial modernization
and technological improvements expand revenues as well as reduce costs.

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Investment Evaluation Criteria
Three steps are involved in the evaluation of an investment:
- Estimation of cash flows
- Estimation of the required rate of return (the cost of capital)
- Application of a decision rule for decision rule for making the choice
Investment decision rule
The investment decision rules may be referred to as capital budgeting techniques, or
investment criteria. A sound appraisal technique should be used to measure the
economic worth of an investment project. The essential property of a sound technique
is that is should maximize the shareholders wealth. The following other characteristics
should also be possessed by a sound investment evaluation criterion:
 It should consider all cash flows to determine the true profitability of then
project.
 It should provide for an objective and unambiguous way of separate good
projects from bad projects.
 It should help ranking of projects according to their true profitability.
 It should recognize the fact that bigger cash flows are preferable to smaller
ones and early cash flows are preferable to later ones.
 It should help to choose among mutually exclusive projects that project which
maximizes the shareholders wealth.
It should be a criterion which is applicable to any conceivable investment project
independent of others.

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1.2 Investment appraisal criteria
Three steps are involved in the evaluation of an investment:
 Estimation of cash flows
 Estimation of the required rate of return (the cost of capital)
 Application of a decision rule for decision rule for making the choice
1.3 Risk and Return Fundamentals
To maximize share price, the financial manager must learn to assess two key
determinants: risk and return. Each financial decision presents certain risk and return
characteristics, and the unique combination of these characteristics has an impact on
share price. Risk can be viewed as it is related either to a single asset or to a portfolio-
a collection, or group, of asset.
Risk:-
Risk is the chance of financial loss. Asset having greater chance of loss are viewed as
more risky than those with lesser chances OF LOSS.
Return:-
The return is the total gain or loss experienced on an investment over a given period
of time. It is commonly measured as cash distribution during the period plus the
change in value, expressed as a percentage of the beginning of period investment
value.
Return and risk are inseparable in investment decision. Scrip‟s return depends on
manyvariables and risk is also associated with the variables which influence the return
on thescrip. Any research should address the variables with which the research is
carried outand once the variables are identified then the research gap can be found
out. The reviewof literature of this study will help the researcher to identify the
factors influencing therisk and return and also the importance of systematic risk in
evaluating investmentdecision. Since the concept of systematic risk stems from
developed market anddeveloping market the literature review covers the study with
respect to foreign contextas well as Indian context.

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1.4 OBJECTIVES OF THE STUDY
 The primary objective of the present project is to know about which method
are highly useful in Foreign companies and Indian companies.
 To understand the basic views of this equipment tools. In different sectors like
manufacturing small scale large scale
 To determine the precise tool for calculating rate of return,this creates a clear
picture for a company.
 As there are many tools for evaluating the return rate we must identify which
tool should be used in which project
 Different company uses different methods so for less confusion company best
equipment must be identified and worked.
 To make sure that the evaluating tool used for finding results are giving the
precise results in any situation.
 To identify the errors, if any, in the calculations due to the budgeting tooland
try solving it by using the proper method.
 To see that by using these tools we can get proper results and any of the
company using it for any project can be satisfied by the outcomes.
 To identified the malware and recover from the data problems by using
methods as per required.
 To recognize NPV and IRR as the best tool for calculating the rate of returns
including all the risks.

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Klammer, Thomas P. (1972) surveyed a sample of 369 firms from the 1969
Compustatlisting of manufacturing firms that appeared in significant industry groups
and made atleast $1 million of capital expenditures in each of the five years 1963-
1967. Respondentswere asked to identify the capital budgeting techniques in use in
1959, 1964, and 1970.The results indicated an increased use of techniques that
incorporated the present value (Klammer, 1984).1&2
Fremgen James (1973) surveyed a random sample of 250 business firms that were in
the1969 edition of Dun and Bradsheet‟s Reference Book of Corporate
Management.Questionnaire were sent to companies engaged in manufacturing,
retailing, mining,transportation, land development, entertainment, public utilities and
conglomerates to
study the capital budgeting models used, stages of the capital budgeting process, and
themethods used to adjust for risk. He found that firms considered the Internal Rate
ofReturn model to be the most important model for decision-making. He also found
that themajority of firms increased their profitability requirements to adjust for risk
andconsidered defining a project and determining the cash flow projections as the
mostimportant and most difficult stage of the capital budgeting process.3
Petty J William, Scott David P., and Bird Monroe M. (1975) examined responses
from109 controllers of 1971 Fortune 500 (by sells dollars) firms concerning the
techniquestheir companies used to evaluate new and existing product lines. They
found that InternalRate of Return was the method preferred for evaluating all projects.
Moreover, they foundthat present value techniques were used more frequently to
evaluate new product linesthan existing product lines.4
1
Klammer, Thomas P.”Empirical Evidence of the Adoption of Sophisticated Capital
BudgetingTechniques,” The Journal of Business, July 1972, 387-397.
2
Klammer, Thomas P. and Michael C. Walker, “The Continuing Increase in the Use of
SophisticatedCapital Budgeting Techniques, “California Management Review, fall 1984, 137-
148
3
Fremgen, James, “Capital Budgeting Practices: A Survey,” Management Accounting , May
1973, 19-25
4
Petty, J. William Petty, David P. Scott, and Monroe M. Bird, “The Capital Expenditure
Decision-MakingProcess of Large Corporations,”The Engineering Economist, Spring 1975,
159-171

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Gitman Lawrence G. and John R. Forrester Jr. (1977) analyzed the responses
from110 firms who replied to their survey of the 600 companies that Forbes reported
as havingthe greatest stock price growth over the 1971-1979 periods. The survey
containingquestions related to capital budgeting techniques, the division of
responsibility for capitalbudgeting decisions, the most important and most difficult
stages of capital budgeting, thecutoff rate and the methods used to assess risk. They
found that the DCF techniques werethe most popular methods for evaluating projects,
especially the IRR. However, manyfirms still used the PBP method as a backup or
secondary approach. The majority of thecompanies that responded to the survey
indicated that the Finance Department wasresponsible for analyzing capital budgeting
projects. Respondents also indicated thatproject definition and cash flow estimation
was the most difficult and most critical stageof the capital budgeting process. The
majority of the firms had a cost of capital or cutoffrate between 10 and 15%, and they
most often adjusted for risk by increasing the minimum acceptable rate of return on
capital projects.5
Kim Suk H. and Farragher Edward (1981) surveyed the 1979 Fortune 100 CFO
abouttheir 1975 and 1979 usage of techniques for evaluating capital budgeting
projects. Theyfound that in both years, the majority of the firms relied on a DCF
method (either the IRRor the NPV) as the primary method and the payback as the
secondary method.6
Marc Ross (1986) In an in-depth study of the capital budgeting projects of 12
largemanufacturing firms, he found that although techniques that incorporated
discounted cashflow were used to some extent, firms relied rather heavily on the
simplistic paybackmodel, especially for smaller projects. In addition, when discounted
cash flow techniqueswere used, they were often simplified. For example, some firms‟
simplifying assumptionsinclude the use of the same economic life for all projects even
though the actual livesmight be different. Further, firms often did not adjust their
analysis for risk. Surveysresults also indicate that project approval at many firms (in
eight out of twelve firmsstudied) follow different criteria depending on the locus of
the decision.7
5
Gitman, Lawrence G. and Forrester, John R. Jr.,”A Survey of Capital Budgeting Techniques
Used byMajor U.S. Firms”, Financial Management, Fall 1977, pg 66-71
6
Kim, Suk H. and Farragher, Edward J,”Current Capital Budgeting Practices,”Management
Accounting,June 1981, pg. 26-30
7
Ross Marc, Capital Budgeting Practices of Twelve Large Manufacturers, Financial
Management (winter1986) vol. 15, issue 4, pp 15-22
Wong, Farragher and Leung (1987) surveyed a sample of large corporations in
HongKong, Malaysia and Singapore in 1985. They found that PBP was the most
popularprimary technique for evaluating and ranking projects in Malaysia. In Hong

10
Kong, theyfound PBP and ARR to be equally the most popular. They concluded that,
in contrast toUS companies where DCF techniques are significantly more popular
than non-DCFtechniques as primary evaluation measures, companies in Hong Kong,
Malaysia andSingapore prefer to use several methods as primary measures in
evaluating and rankingproposed investment projects. It is also observed that
companies in Hong Kong, Malaysiaand Singapore do not undertake much risk
analysis, neither attempting to assess risk noradjust evaluation criteria to reflect risk.
The most popular risk assessment techniqueswere sensitivity analysis and scenario
analysis (high-medium-low forecasts).8
Stanley (1990) has studied capital budgeting techniques used by small business firms
inthe 1990s. According to Eugene Brigham, in his book „Fundamentals of
FinancialManagement‟ in the chapter “Capital Budgeting in the Small Business
Firms” , capital
budgeting may be more important to the smaller firm than its larger counterparts
becauseof the lack of diversification in a smaller firm. He says that a mistake in one
project maynot be offset by successes in others. His intention of the study is to
ascertain where smallfirms stand today in regard to capital budgeting techniques as
opposed to prior decades.He selected 850 small firms out of which he received 232
usable responses to the study.As per his findings, a number of patterns relating to
capital budgeting by smaller firms areworthy to note. The firms continue to be
dependent on the payback method as the primarymethod of analysis. This is not
necessarily evidence of a lack of sophistication, as muchas it is a reflection of the
financial pressures put on the small business owner by financialinstitutions. The
question to be answered is not always how profitable the project is, buthow quickly a
loan can be paid back. Small business owners have increasedsophistication as over
27% use discounted cash flow as the primary method of analysis.Stanley opines that
their conclusions may, at times, be somewhat misleading due to aninappropriate
discount rate. Small firms take risk very seriously which is reflected by ahigher
required rate of return for risky projects. 9
Jog and Srivastava (1991) provide direct empirical evidence on the capital budgeting
process based upon a survey of large Canadian corporations. They explored many
issuesviz., the use of capital budgeting techniques, cash flow forecasting methods,
risk analysistechniques and methods used to estimate the cost of capital and the cost
of equity. Hisfindings are most firms used multiple capital budgeting methods to
assess capitalinvestments; DCF methods were employed by more than 75% of our
respondents toevaluate projects such as expansion-existing operations, expansion-new
operations,foreign operations and leasing.
8
Wong K A, Farragher E J and Leung R K C, Capital Investment Practices: A Survey of
Large Corporations in Malaysia, Singapore and Hong Kong, Asia Pacific Journal
ofManagement, January 1987, pp 112-123
9
Block Stanley; Capital budgeting techniques used by small business firms in the 1990s, The
EngineeringEconomist, Summer 1997, v42 n4 p289(14)
It appears that the propensity to use DCF techniquesincreases with the complexity of
the decision of the DCF methods, IRR was used morefrequently than NPV in most

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cases, of the two rules of thumb, he observed little use ofARR. Payback is used much
more frequently in conjunction with DCF methods.According to them, the use of DCF
methods has become a norm in Canadian firms andthat multiple evaluation criteria are
being commonly used. Management‟s subjectiveestimates are used as often to
generate a cash flow forecast as quantitative methods.Sensitivity analysis is the most
popular technique among quantitative methods used incash flow estimation, possibly
reflecting the popularity of pc-based spreadsheet programs.The estimation of cost of
capital also seems to be based more often on judgment than onany formal models. A
significant number of firms use non-standard discount rates, i.e.,rates other than the
WACC and those using it seem to rely on judgmental or non-standardmethods of
estimation for their cost of equity, the standard methods being either theCAPM or the
dividend growth model. Compared to previous studies, he found the usagerate for
DCF methods is higher. However, the use of subjective, judgmental and
nonstandardtechniques in the estimation of cash flows, risk analysis and the
estimation of theappropriate cost of capital continues to be high.10
Bierman (1993) finds that 73 of 74 Fortune 100 firms use discounted cash flow
(DCF)analysis, with internal rate of return (IRR) being preferred over net present
value(NPV).The payback period method also remains a very popular method in
practice, though notas a primary technique. 93 per cent of the respondents use
company-wide WACC fordiscounting free cash flows and 72 per cent use the
discount rate applicable to projectbased on its risk characteristics.11
Bierman Harold (1993) surveyed Fortune 500 industrial companies regarding the
capitalbudgeting methods used by these firms in 1993. He found that every
responding firmused some type of DCF method. The payback period was used by 84
percent of hissurveyed companies. However, no company used it as the primary
method, and mostcompanies gave the greatest weight to a DCF method. 99 percent of
the Fortune 500companies used IRR, while 85 percent used NPV. Thus, most firms
actually used bothmethods. 93 percent of companies calculated a weighted average
cost of capital as part oftheir capital budgeting process. A few companies apparently
used the same WACC for allprojects, but 73 per cent adjusted the corporate WACC to
account for project risk, and 23per cent made adjustments to reflect divisional risk.12
10
Jog Vijay M and Srivastava Ashwani K., Capital budgeting practices in corporate Canada,
FinancialPractice & Education, Fall/Winter 1995, pp 37-43
11
Bierman H J (1993), Capital Budgeting in 1992:A Survey, Financial Management,
Vol.22,p.24
12
Harold Bierman, “Capital Budgeting in 1993: A Survey,”Financial Management, Autumn
1993,24

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Drury, Braund and Tayles’ (1993) survey of 300 manufacturing companies with
annualsales exceeding £20 million indicates that payback (86%) and IRR (80%) are
the mostwidely used project appraisal methodologies. The most widely used project
risk analysistechnique is sensitivity analysis. Forty-nine per cent of the respondents do
not usestatistical analysis for risk analysis and 95 per cent of the respondents never
use eitherCAPM or Monte Carlo simulation due to lack of understanding.13
Petry and Sprow’s (1993) study of 151 firms listed in the 1990 Business Week
1,000firms indicates that about 60 per cent of the firms use the traditional payback
period eitheras a primary or as a secondary method for capital budgeting decisions.
Ninety per cent ofthe firms use NPV and IRR either as a primary or as a secondary
capital budgetingdecision methodology. Most of the financial managers indicated that
either they had notheard of the problems of IRR (multiple rates of return, NPV and
IRR conflict) or suchproblems rarely occurred.14
Joe Walker, Richard Burns, and Chad Denson (1993) focused on small companies.
They noted that 21 percent of small companies used DCF. They also observed that
withintheir sample, the smaller the firm, the smaller the likelihood that DCF would be
used. Thefocal point of their study was why small companies use DCF so much less
frequently thanlarge firms. The three most frequently cited reasons, according to the
survey, were (1)small firms‟ preoccupation with liquidity, which is best indicated by
payback, (2) a lackof familiarity with DCF methods, and (3) a belief that small project
sizes make DCF notworth the effort.15
Richard Pike (1996) has done a longitudinal capital budgeting study based on
surveysconducted between 1975 and 1992 compiled by conducting cross-sectional
surveys on thesame firms at approximately five yearly intervals. According to him,
over the 17-yearreview period, there have been the greatest changes in the areas of
risk analysis, NPVanalysis and post-completion audits. The usage of DCF techniques
have increased witheach survey. His other findings are that firm size is still
significantly associated withdegree of use for DCF methods but not for payback and
the use of ARR is unchanged. Itis suggested that firm size per se may not be the direct
causal factor in determining use ofsophisticated methods; size of firm influences the
use of computer based capitalbudgeting packages which, in turn, influence the use of
discounting methods, sensitivityanalysis, and risk analysis techniques. Once size
ceases to be associated with use ofcomputers in capital budgeting it is envisaged that
it will also have far less impact oncapital budgeting technique usage rates.
13
Drury C,Braund S and Tayles M (1993), A survey of Management Accounting Practices in
UKManufacturing Companies, ACCA Research Paper 32, Chartered Association of Certiifed
Accountants
14
Petry Glenn H and Sprow James (1993), The Theory of Finance in 1990s, The Quarterly
Review ofEconomics and Finance, pp 359-381
15
Joe Walker, Richard Burns, and Chad Denson, “Why Small Manufacturing Firms Shun
DCF,” Journal ofSmall Business Finance, 1993, 233-249

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He has reported the general increase in so-calledsophisticated capital budgeting
techniques to a point where the gap between theory andpractice is trivial, at least for
large firms due to three main factors viz., technical,educational and economic. This
paper has sought to provide a more reliable andcomprehensive analysis of how capital
budgeting practices in large UK companies haveevolved in recent years and, in so
doing, provide a clearer backdrop against which earlierstudies can be interpreted and
future studies enacted.16
John J Binder and J. Scott Chaput (1996) in their article „A Positive analysis
ofCorporate Capital Budgeting Practices‟ theoretically and empirically investigates
thechoice of capital budgeting methods by large US corporations over time.
Simpleeconomic analysis indicates that there are costs and benefits to using the
various decisionrules that are commonly found in the corporate world. This analysis
makes predictionsabout how capital budgeting practices will change over time, which
they test by relatingthe percentage of large firms that use DCF rules to several
variables that measure thesecosts/benefits. Empirically they find that, controlling for
differences in the respondentsacross surveys, the use of DCF methods is positively
correlated with both the AAA bondyield (i.e. the cost of ignoring the time value of
money) and positively related to measuresof how well these methods are understood
in the corporate world (e.g., the percentage ofMBAs in the population). According to
them, increased uncertainty causes firms to usenon-DCF rules more heavily. Their
findings are consistent with the hypothesis that firmsdo a cost-benefit calculation
when determining which capital budgeting rule(s) to employ.These rules can help
reorient academic thinking away from looking at some popularcapital budgeting
methods as wrong and move it more toward explaining why real worldpractice has
been and is as it is. The hypotheses presented by them suggest new directionsfor
surveys of corporate capital budgeting practices. That is, beyond asking firms to
listthe methods they use it would be interesting to explore in more detail which
methods areused for different types of projects and why. They says that additional
surveys of this typemay provide valuable new insight into firms‟ choice of capital
budgeting methods.Cost-benefit analysis suggests that DCF methods will be used
more frequently for largeprojects, where the total cost of using an inaccurate method
is large, as opposed to smallprojects. Similarly, firms may use different methods for
short-term projects than for longtermprojects. He also suggests to examine capital
budgeting methods across differentcountries.17
Colin Drury and Mike Tayles (1996) has focused a light on some of unresolved
issueson capital budgeting in UK and examined the impact of company size on the
use offinancial appraisal techniques. They conducted a postal questionnaire survey
which canprovide an overview of current management accounting practices in UK
companies. Theymailed their questionnaire to 866 business units and a total 303
usable responses werereceived (a response rate of 35%).
16
Pike Richard, A longitudinal survey on capital budgeting practices, Journal of Business
Finance &Accounting, 23(1), January 1996, 0306-686X, pp79-92
17
Binder John J. and Chaput Scott J., A positive analysis of corporate capital budgeting
practices, Reviewof quantitative finance and accounting, 6(1996):pp 245-257

14
Their survey findings in respect of the 46 largestorganizations indicated that 63%
always used IRR, 50% always used NPV and 30%always used the payback method.
The sample included in this survey included responsesfrom a wide range of
organizations of different size. Most of organizations used acombination of appraisal
techniques. 86% of those organizations that „often‟ or „always‟used the unadjusted
payback method combined it with a discounting method. The surveyfindings also
indicate that non discounting methods continue to be used by both smallerand larger
organizations. The survey also sought to ascertain the approaches that wereused for
dealing with project risk. Sensitivity analysis was „often‟ or „always‟ used by82% of
the larger organizations compared with 30% for the smaller organizations. Thesurvey
findings suggest that theoretically sound capital budgeting techniques are morelikely
to be used by larger organizations rather than by smaller organizations. The impactof
company size on the use of investment appraisal techniques has been examined and
thesurvey findings suggest that many firms appear to deal with inflation incorrectly
whenappraising capital investments. This survey has provided useful attention-
directinginformation by identifying topics that require most in-depth research. They
havesuggested that in order to understand more fully the role that financial criteria
play in thecapital investment decision-making process, future studies should widen
the scopebeyond economic rationality and examine the broader political and social
roles thatfinancial information plays within organizations in the investment decision-
making process.18
Kester, George W & Chong Tsui Kai (1996) has studied Capital Budgeting
Practices ofListed Firms in Singapore. They took a sample size of 211 companies and
the surveyresulted in 54 responses. They found that the responding executives in
Singaporeconsidered IRR and payback to be equally important for evaluating and
ranking capitalinvestment projects. For assessing risk, Scenario analysis and
Sensitivity analysis wereperceived to be the two most important techniques while
more sophisticated probabilistictechnique were seldom used by companies. In
selecting the discount rates for projectevaluation, about half the executives indicated
that their firms based a project‟s minimumacceptable rate of return on the cost of the
specific capital used to finance the project.Multiple risk-adjusted discount rate are
used by only 37.8% of respondents and themajority adjusted for risk by classifying
projects into subjectively-defined risk categories.None of the respondents used the
CAPM to determine project discount rates. Inestimating the cost of equity capital, a
major component of a firm‟s WACC, the resultswere split evenly between the
dividend yield plus expected growth rate and risk premiummethods. Only 17% of the
respondents indicated that their firms used the CAPM toestimate the cost of equity
capital. The survey results also indicated that most of the firmsevaluating project
cashflows on an after-tax basis and the majority of firms do notpractice capital
rationing.19
18
Drury Colin and Tayles Mike, UK capital budgeting practices: some additional survey
evidence,European journal of finance 2,pp 371-388 (1996)
19
Kester, George W, and Tsui Kai Chong, Capital budgeting practices of listed firms in
Singapore,Singapore Management Review, pp 9-23

15
Kester and Chang (1999) survey 226 CEOs from Australia, Hongkong,
Indonesia,Malaysia, Philippinnes, and Singapore and find that DCF techniques such
as NPV/IRRare the most important techniques for project appraisal except in Hong
Kong andSingapore. Sensitivity analysis and scenario analysis are found to be the
most importanttool for project risk assessment in all the countries. Nearly 72 per cent
of the respondentsin Australia use CAPM to calculate the cost of equity. The risk
premium method (cost ofdebt plus risk premium) is most popular in Indonesia
(53.4%) and Philippines (58.6%).The dividend yield plus growth rate method is the
most popular method in Hong Kong(53.8%).20
Block Stanley (2000) has analyzed the capital budgeting policies of 146 multinational
companies in light of current financial theory. He has examined that some of the
actions thatMNCs take in the capital budgeting area are the logical extensions of
domestic practices intothe international area, while others appear to be misguided
changes to normal capital budgetingprocedures. According to his study, there are a
number of misapplications such as applyingcorporatewide weighted average cost of
capital to foreign affiliate cash flows rather than tocashflows actually remitted to the
corporations. Also, risk is frequently measured on a localproject basis (in a foreign
country) rather than considering the portfolio effect on the totalcorporations. Of the
146 survey respondents in this study, 68.7% believe that internationalinvestments
increase the risk exposure of the firm and establish policies on that premise.Finally,
he has shown that the survey respondents hedge against the uncertainty of
theprocedures by adding a premium to the weighted average cost of capital as
computed byfinancial analysts given the inconsistent procedures that are often utilized
in going fromdomestic to international capital budgeting.21
Arnold Glen C. and HatzopoulosPanos D. (2000) has done a study of The Theory-
Practice Gap in Capital Budgeting: Evidence from the United Kingdom to consider
theextent to which modern investment appraisal techniques are being employed by the
mostsignificant UK corporations. It also explores some of the reasons for the
continuing highuse of traditional, rule-of-thumb techniques, alongside DCF
techniques. They selected300 UK companies taken from the Times 1000 (1996)
ranked according to capitalemployed. Out of these companies, their response rate was
32.4%. The results of theirresearch had been compared with Pike (1982, 1988 and
1996) and McIntyre andCoulthurst(1985) as they have similar characteristics.
Surprisingly in contrast to otherstudies, they observed a reduction in the use of PBP at
high level. This survey evenpresents evidence that the theory-practice gap has been
narrowed. Over 90% of SMEs areusing either NPV or IRR. 97% of large firms use
NPV compared with 84% which employIRR. Thus NPV has overtaken IRR as the
most widely used method. This study revealedthat 67% of firms using three or more
methods. They observed a wide theory-practice gapconcerning the use of risk analysis
techniques.
20
Kester George W and Chang Rosita P (1999), Capital Budgeting Practices in the Asia-
PacificRegion:Australia, Hong Kong, Indonesia, Malaysia, Philippines and Singapore,
Financial Practice andEducation, Vol 9, No.1, pp 25-33
21
Block Stanley; Integrating traditional capital budgeting concepts into an
internationaldecision-makingenvironment, The Engineering Economist, 2000, volume 45,
Number 4, pp 309-325

16
While textbooks and academics paperadvocate the use of probability analysis but in
their study it seems managers‟ revealedhesitancy of using it on behavioral, practical,
and theoretical ground. Over three-quartersof the firms surveyed adjust for inflation
either by specifying cashflows in constant priceterms applying a real rate of return or
by expressing cashflows in inflated price terms anddiscounting at the market rate of
return. Capital expenditure ceilings are placed onoperating units which lead to the
rejection of viable projects in the case of 49% of firms.Thus the central aim of this
study is to generate new evidence concerning the capitalinvestment practices of UK
firms.22
Graham and Harvey (2001) surveyed 392 chief financial officers (CFOs) about their
companies‟ corporate practices. Of these firms, 26% has sales less than $100
million,32% had sales between $100 million and $1billlion, and 42% exceeded
$1billion. The
CFOs were asked to indicate how frequently they use different approaches for
estimatingthe cost of equity: 73.5 per cent use the Capital Asset Pricing Model
(CAPM), 34.3 percent use a multi beta version of the CAPM, and 15.7 per cent use
the dividend model. TheCFOs also use a variety of risk adjustment techniques, but
most still choose to use asingle hurdle rate to evaluate all corporate projects.The
CFOs were also asked about the capital budgeting techniques they use. Most useNPV
(74.9 per cent) and IRR (75.7 per cent) to evaluate projects, but many (56.7per
cent)also use the payback approach. These results confirm that most firms use more
than oneapproach to evaluate projects.The survey also found important differences
between the practices of small firms (lessthan $ 1 million in sales) and large firms
(more than $1 billion in sales). Consistent withearlier studies, Graham and Harvey
found that small firms are more likely to rely on thepayback approach, while large
firms are more likely to rely on the NPV and/or IRR.The firms with high debt ratios
are significantly more likely to use NPV and IRR thanfirms with low debt ratios.
They find that CEOs with MBA are more likely than non-MBA CEOs to use NPV
technique. Small firms use cost of equity capital based on “whatinvestors tell us they
require”. CEOs with MBAs use CAPM as against non-MBA CEOs.Nearly 58% of the
respondents use the company-wide discount rate to evaluate theprojects though the
project may have different risk characteristics. Large firms are morelikely to use risk-
adjusted discount rate than small firms.23
Ryan Patricia A and Ryan Glenn P. (2002) have examined the capital
budgetingdecision methods used by the Fortune 1000 companies. According to him,
managementviews NPV as the most preferred (96%) capital budgeting tool, which
representsalignment between corporate America and academia and even alignment of
theory andpractice. Firms with larger capital budgets tend to favour NPV and IRR.
PBP is used atleast half of the time by 74.5% of the respondents. Fourth in popularity
was thediscounted payback model used atleast half of the time by 56.7% of the
companies.Finally at least half time usage was reported for the three models as
follows.
22
Arnold Glen C. and HatzopoulosPanos D., The theory-practice gap in capital
budgeting:evidence fromthe United Kingdom, Journal of Business Finance & Accounting,
27(5) & (6), June/July 2000, 0306-686X,pp 603-626
23
Graham John R. and Harvey Campbell R.(2001); The theory and practice of corporate
finance: Evidencefrom the field, Journal of Financial Economics, Vol 60, Nos 2&3, pp187-
243

17
PI ranks fifthat 43.9%, followed by ARR at 33.3% and finally, MIRR at 21.9%.In
case of Advanced Capital Budgeting methods, the sensitivity analysis was the
mostpopular tool followed by scenario analysis. Inflation adjusted cash flows were
used by46.6% respondents on a regular basis. EVA was used by over half of
respondents whileMVA was used by approximately one third. Incremental IRRs were
used by 47.3% of therespondents, while simulation models were used by 37.2%.
PERT/CPM charting andDecision trees were each used by about 31% of the firms
while the more complexmathematical models such as liner programming and option
models receive less corporateacceptance. As per Ryans, it appears that the views of
academics and senior financialmanagers of Fortune 1000 companies on basic capital
budgeting techniques are instronger agreement. Discounted capital budgeting methods
are generally preferred overnon-discounted techniques which may reflect the
increased financial sophistication andavailability of inexpensive computer technology.
The vast majority of respondents agreethat WACC is the best starting point to
determine the appropriate discount rate.24
AkaluMehariMekonnen (2002) has made an attempt to evaluate the capacity
ofstandard investment appraisal methods indicating the existence of gap between
theory andpractice of capital budgeting. He observed that when the amount of
spending is large andthe life of a project is longer, companies tend to use more
quantitative and advancedappraisal methods. Most of the companies (65.8%) use
multiple models of appraisal outof 217 respondents for reducing the chance of
discrepancy between actual and estimatedrevenue and cost of a project. The survey
reveals the existence of correlation betweennumber of times that a project is
monitored and its value discrepancy. More than 30% ofrespondents surveyed reports
that the NPV method creates larger discrepancy among thestandard appraisal
methods. The survey result shows the growing trend in the use of valuemanagement
technique. Further, it revealed the absence of uniformity in the use ofvaluation
methods throughout the project life span. More than half of the samples
performproject appraisal and subsequent project evaluation by two different sets of
models whichcreates confusion in the interpretation of the progress result of a project
and makecompanies to keep running value-destroying projects.25
Stanley Block (2003) has studied the use of capital budgeting procedures
betweenindustries. Three hundred two Fortune 1000 companies responded to a survey
organizedby Stanley along industry lines viz., Energy, Manufacturing, Finance,
Utilities,Technology, Retail, Healthcare, Transportation. This study emphasizes that
just asindustry patterns affect financing decisions (debt vs. equity), they also affect
capitalbudgeting decisions. In this study, the author developed the breakdown of
industries aftera careful analysis of performance metrics, size variations, operational
procedures andmanagement strategy.
24
Ryan Patricia A. & Ryan Glenn P.; Capital Budgeting Practices of the Fortune 1000:How
Have Things Changed?, Journal of Business and Management, Volume 8, Number 4, Winter
2002.
25
AkaluMehariMekonnen; Evaluating the capacity of standard investment appraisalmethods,
TinbergenInstitute Discussion Paper, 30 July 2002

18
In this study of eight major industrial classifications covering 302Fortune 1000
companies, Five key areas related to capital budgeting were covered. Ineach case, a
statistical test was employed to determine whether there was a difference
inmethodology between industries. Overall, this study shows that, just as
industrycharacteristics often affect the financing patterns of firms (debt vs. equity),
they alsoaffect the asset deployment decisions. This study brings the left-hand side of
the balancesheet upto the level of the right-hand side in terms of industry analysis.26
Ioannis T. Lazaridis (2004) had done a survey of capital budgeting practices of the
firmsin Cyprus. He found that only 30.19% of the sample firms use capital budgeting
techniques for all their investment decisions, while 50.94% of the firms use evaluation
methods for only some types of investment above a certain cost level.
Unfortunately,18.99% of the companies do not use any evaluation method for their
investment projects.The survey shows that 54.43% of projects evaluation is done by a
simplified evaluationtechnique and that 36.71% of the companies use the PBP
technique. Among the methodsthat take into account the time value of money, the
NPV method is the one mostcompanies prefer (11.39%). Total statistical risk analysis
is being adopted by 31.67% ofthe firms. The survey with respect to the cost of capital,
an important element in the useof the capital budgeting techniques, shows that is
determined basically according to thecost of borrowing (30.95%), while 3.57% of the
companies believe that determining thecost of capital does not affect their profits. He
has concluded that SMEs in Cyprus do notfollow scientific evaluation techniques for
their investment projects probably due to lackof familiarity with such methods. These
findings indicate the need for training andeducating the managers of the firms in the
capital budgeting area of financialmanagement.27
Vaihekoski Mika and Liljeblom Eva (2004) conducted a survey of 144
companieslisted on the Helsinki Stock Exchange to examine the practice of the use of
investmentevaluation methods and required rate of return in Finnish. The results show
that theFinnish companies still lag behind US and Swedish companies in their use of
the NPV,and the IRR method, even though it has become more commonly used
during the last tenyears. The PBP method and IRR are the two most popular primary
methods used toevaluate investment projects. CAPM is used in surprisingly few
companies, and 27% ofthe companies have not even defined their required rate of
return on equity. The CAPMor multibeta model is used only in some 40% of the
companies as the primary orsecondary method in setting the cost of equity capital.
The median required rate of returnfor the capital is between 12-14%. But more than
20% of the companies have arequirement above 20%.
26
Block Stanley; Are there any differences in capital budgeting procedures between
industries? Anempirical study, The Engineering Economist, 50, pp 55-67
27
LazaridisIoannis T., Capital budgeting practices: A survey in the firms in Cyprus, Journal of
smallbusiness management 2004 42(4), pp. 427-433
28
Eva Liljeblom and Mika Vaihekoski; INVESTMENT EVALUATION METHODS AND
REQUIREDRATE OF RETURN IN FINNISH PUBLICLY LISTED COMPANIES, January
8, 2004

19
Hogaboam, Liliya S. and Shook Steven R.(2004) examined the capital
investmentpractices of publicly owned forest products firms in the United States that
trade stock onthe NYSE and NASDAQ in 2001 by replicating research reported by
Cubbage and
Redmond in 1985. They obtained 19 valid responses (24% response rate) out of 79
firmsselected to represent the forest products industry operating in the US. His
researchrevealed that the majority of firms (52.6%) perform formal analysis for
projects that aregreater than $10,000. DCF techniques are the most preferred capital
budgeting decisioncriteria used in the forest products industry. IRR was ranked
highest by the majority offirms (52.9%) while 9 firms ranked either first or second in
evaluation criteriaimportance. Incase of mutually exclusive projects IRR (46.7%) was
considered as theirprimary choice in capital rationing. Some larger companies
indicated frequent use ofmore sophisticated evaluation methods, such as Economic
Value Analysis. The employeesafety was the most important qualitative factor
influencing the investment decision of thefirm followed by environmental
responsibility. The probability of not achieving a targetreturn is the main reason an
investment is considered to be risky by more than threequartersof the 17 respondents;
second was uncertain market potential followed byentering an inexperienced area.
The subjective approaches were selected for evaluatingrisky investments by the
respondents.29
Hermes, N., Smid, P., Yao, L. (2006) compared the use of capital budgeting
techniquesof Dutch and Chinese firms, using data obtained from a survey among 250
Dutch and 300Chinese companies. They have analyzed the use of capital budgeting
techniques bycompanies in both countries from a comparative perspective to see
whether economicdevelopment matters. The empirical analysis provides evidence that
Dutch CFOs on anaverage use more sophisticated capital budgeting techniques than
Chinese CFOs do. Theirfindings suggest that the difference between Dutch and
Chinese firms is smaller thanmight have been expected based upon the differences in
the level of economicdevelopment between both countries, at least with respect to the
use of methods ofestimating the cost of capital and the use of CAPM as the method of
estimating the costof equity. The NPV method is more preferred by Chinese firms
while IRR method ismore popular among Dutch firms.30
Truong G., Partington and Peat M. (2006) surveyed Australian firms which
revealedthat real options techniques have gained a toehold in Australian capital
budgeting but arenot yet part of the mainstream. Projects are usually be evaluated
using NPV, but thecompany is likely to also use other techniques such as the PBP.
The project cash flowprojections are made from three to ten years into the future. The
project cash flow will bediscounted at the WACC as computed by the company, and
most companies will use thesame discount rate across divisions. The discount rate
will also be assumed constant forthe life of the project. The WACC will be based on
target weights for debt and equity.
29
HogaboamLiliya S. and Shook Steven R., Capital budgeting practices in the U.S. forest products
industry: A reappraisal, Forest Products Journal, December 2004,Vol.54, No. 12, pp 149-158
30
Hermes, N. & Smid, P. & Yao, L.(2006),"Capital Budgeting Practices: A comparative Study of the
Netherlands and China," University of Groningen, Research Institute SOM(Systems, Organisations and
Management) in its series Research Report with number 06E02

20
The CAPM will be used in estimating the cost of capital, with the T-bond used as
aproxy for the risk free rate, the beta estimate will be obtained from public sources,
and themarket risk premium will be in the range of 6% to 8%. Asset pricing models
other thanthe CAPM will not be used in estimating the cost of capital.31However,
consistent with recent overseas studies, Graham and Harvey (2001) and Bruner,et. Al.
(1998) the CAPM is the most popular method used in estimating the cost of capitalin
Australia. Kester et al (1999) found that 73% of companies surveyed in six Asia
Pacificcountries, used CAPM. Compared to two previous surveys of US companies,
Gitman and Mercurio (1982) and Gitman and Vandenberg (2000), increasing
popularity of the CAPMmodel is apparent.31
Lord Beverley R. and Boyd Jennifer R. (2004) surveyed half of the New Zealand
localauthorities to find out how they undertook capital budgeting. This study was
laterextended to all New Zealand local authorities. Results of the two surveys show
that 75%of local authorities use cost-benefit analysis and NPV in financially
evaluating capitalinvestments. However, compared to studies of the private sector,
there is a greater focuson qualitative aspects of decision-making. Post-audits were
also highly used, but with afocus on quantitative information.32
Cooper William D., Morgan Robert G., Regman Alonzo, Smith Margart (2001)
hasdone a study to assess the current level of capital budgeting sophistication in
CorporateAmerica. A survey questionnaire was sent to the CFOs of the Fortune 500
companies.They received response from 113 companies having a response rate of
23%. As per theresults of their study, the most commonly used primary capital
budgeting evaluationtechnique is the IRR (57%). The second most popular technique
is the PBP (20%). Themost popular backup technique is the PBP (23%), which is
slightly more popular than theIRR and the NPV (21%). Many firms use a team
approach to evaluate capital projects.The largest number of their respondents believes
that project definition and cashflowestimation is the most important and difficult stage
of the capital budgeting process.Majority of the firms used cutoff rate between 10%
and 15%. The most popular methodof handling risk in the capital budgeting process
identified by 33% of the respondents wasto increase the required rate of return of cost
of capital.
31
Truong G., Partington and Peat M. (2006), “ Cost of Capital Estimation and
CapitalBudgeting practice inAustralia,” Available from:
32
Lord Beverley R. and Boyd Jennifer R.; Capital Budgeting in New Zealand Local
Authorities: AnExamination of Practice, Accepted for Presentation at the Fourth Asia Pacific
Interdisciplinary Research inAccounting conference, 4 to 6July 2004, Singapore,
ww.smu.edu.sg/events/apira/2004/FinalPapers/1176-Lord.pdf
33
Cooper, Morgan, Redman and Smith; Capital budgeting models: Theory Vs. Practice;
Business Forum,2001, Vol. 26, Nos. 1,2, pp. 15-19
Literature Review : Indian StudiesPrasanna Chandra (1975) conducted a survey
of twenty firms to examine theimportance assigned to economic analysis of capital
expenditures, methods used and itsrationale for analyzing capital expenditures and
ways to improve economic analysis ofcapital expenditures. The findings of the study
reveals that the nature of economicanalysis of capital expenditures varies from project

21
to project but in most of the firmssurveyed the analysis is done in sketchy terms. The
most commonly used method forevaluating investments of small size is the PBP and
for large size investments the ARR isused as the principal criterion and the PBP is
used as a supplementary criterion. DCFtechniques are gaining importance particularly
in the evaluation of large investments.Several other criterias such as profit per rupee
invested, cost saving per unit of product,investment required to replace a worker are
used for evaluating investments. Most of thefirms do not have fixed standards for
acceptance/rejection of projects. The most commonmethods used for incorporating
the risk factor into the capital expenditure analysis areconservative estimation of
revenues, safety margin in cost figures, flexible investmentyardsticks, acceptable
overall certainty index and judgement on three point estimates ofrate of return.34
Porwal L S (1976) had done an empirical study of the organizational,
quantitative,qualitative, and behavioural and control aspects of capital budgeting in
largemanufacturing public limited companies in the private sector in India. He had
selected
118 companies out of which 52 companies (44%) provided usable responses.
Themajority of the companies studied give more importance to earning more profits
orachieving a higher accounting rate of return on investment in assets. The final
authority tomake a capital expenditure decision rests with the Board of Directors
(BOD) in case offour-fifths of the companies. Important key stages in the capital
expenditure process are-(i) initiation, (ii) evaluation, (iii) approval and (iv) control.
Though 44% of therespondents ranked first preference for DCF techniques, however,
most companies wereusing combination of traditional and „theoretically correct‟
economic evaluationtechniques of capital expenditure proposals. IRR is favoured for
new product lineswhereas ARR is most favoured in case of existing product lines but
PBP continues to bethe next favoured technique. Competitive position is the main
non-financial factor that isgiven due consideration for the capital budgeting decision.
High profitability companiesprefer „cost of funds used to finance the expenditure‟
more than the WACC fordetermining the cut-off point. Capital rationing is not much
of a problem in Indianindustries. So far as risk in the capital budgeting is concerned,
uncertainty in theavailability of inputs, inability to predict key factors and uncertainty
in government policyare reasons of project risk. Most companies in India are using
one or more methods forincorporating risk. The shorter payback period and higher
cut-off rate are the populartechniques used by companies in India. Priorities and
higher rate of return are the twomain criteria for minimizing disappointment and
perceived conflict among thedepartments of a firm. For controlling capital
expenditures, about two-thirds of thecompanies under study have reported that they
adopt post-audit.35
34
Chandra Prasanna, “Risk analysis in capital expenditures”, Indian Management, October
1975
35
PorwalL.S.:Capital Budgeting in India, Sultan Chand & Sons
Pandey I M (1989) In a study of the capital budgeting practices of fourteen medium
tolarge size companies in India, it was found that all companies, except one, used
payback.With payback and/or other techniques about two-thirds of companies used
IRR and abouttwo-fifths NPV. IRR was found to be the second most popular method.
The reasons forthe popularity of payback in order of significance were stated to be its

22
simplicity to useand understand, its emphasis on the early recovery of investment and
focus on risk. It wasfound that one-third of companies always insisted on the
computation of payback for allprojects, one-third for majority of projects and
remaining for some of the projects. Forabout two-thirds of companies‟ standard
payback ranged between 3 and 5 years.According to his survey, reasons for the
secondary role of DCF techniques in Indiaincluded difficulty in understanding and
using these techniques, lack of qualifiedprofessionals and unwillingness of top
management to use DCF techniques. For capitalrationing it is found that most
companies do not reject projects on account of capitalshortage. They face the problem
of shortage of funds due to the management‟s desire tolimit capital expenditure to
internally generated funds or the reluctance to raise capitalfrom outside. But generally
companies do not reject profitable projects under capitalrationing; they postpone them
till funds become available. The most commonly usedmethods of risk analysis in
practice are sensitivity analysis and conservative forecasts.Except a few companies
most companies do not use the statistical and other sophisticatedtechniques for
analyzing risk in investment decisions.36
Sahu P K (1989) has done a study on Capital budgeting in corporate sector in the
state ofOrissa. He made an attempt to study the trends in fixed investment and its
financingbetween 1960-61 to 1973-74. He took a sample of 15 companies. It was
observed thatroutine investments were financed through internal sources of funds
while investmentsfor the growth purpose are financed through the external sources of
funds. Short termfinancing is generally used for financing fixed investments only
during growth periodsand that too for short periods. It was observed that PBP and
ARR were the methodsgenerally preferred by firms followed by discounting methods
NPV and IRR.37
Dhankar R S (1995) examined methods of evaluating investments and uncertainty in
Indian companies. He selected a sample of 75 firms. His findings revealed that 33%
offirms used non-discounted methods like PBP and ARR whereas 16% of companies
wereusing modern DCF techniques. Moreover, almost 50% of the companies
incorporated riskby „Adjusting the Discount Rate‟ and „Capital Asset Pricing
Model‟.38
36
Pandey I. M., Capital Budgeting Practices of Indian Companies; MDI Management Journal,
Vol. 2, No.1(Jan. 1989)
37
Sahu P K (1989), Capital Budgeting in Corporate Sector,Discovery Publishing House, Delhi
38
Dhankar R S (1995), “An Appraisal of Capital Budgeting Decision Mechanism in Indian
Corporates”,Management Review, July-December, pp. 22-34
U. Rao Cherukuri’s(1996) survey of 74 Indian companies revealed that 51% use
IRR asproject appraisal criterion. Firms typically use (92% or more) multiple
evaluationmethods. ARR and PBP are widely used as supplementary decision criteria.
WACC is thediscount rate used by 35% of the sample firms. The most widely used
discount rate is15%, and over 50% use an after-tax rate. About three-fifths of the

23
respondents explicitlyconsider risk in capital project analysis and mostly use
sensitivity analysis for purposes ofrisk assessment. The most popular method used by
respondents to adjust for risk isshortening the PBP followed by increasing the
required rate of return. 35% of therespondents included leasing in the capital
budgeting process. A few Indian firms in hissurvey also used none of the methods
listed on questionnaire. They were usingprofitability and cash flow analysis for
assessing capital expenditure. Apart from theformal budgeting techniques due
weightage is given to qualitative aspects like qualityimprovement expected from the
capital expenditure, capital expenditure for enhancedsafely and capital expenditure to
meet statutory requirements and for benefit to thecompany‟s personnel from health
considerations and social benefits like housing. Thefavorite capital budgeting methods
of earlier years, ARR (about 19%) and PBP (about38%) have been used as primary
methods.39
C PrabhakaraBabu&Aradhana Sharma (1996) had done an empirical study on
capitalbudgeting practices in Indian Industry. The authors have conducted a survey of
73 companies inand around Delhi and Chandigarh. They used personal interview
method. It has been found bythem that 90% of companies have been using capital
budgeting methods. Around 73% of thecompanies have been using DCF methods.
The popular investment appraisal methods are the„IRR‟ and the „PBP‟, used either
individually or jointly. Around 70% executives felt that it ispossible to estimate
accurately the cash flows associated with each capital investmentseparately. They
have observed that capital investment proposals are prepared by the
concerneddepartments and the final decision is vested with other
personnel/committee. The populardiscount rate used by the firms is „the term lending
rate of financial institutions‟ closelyfollowed by „cost of capital‟. The most often used
method to resolve the uncertainty in thefuture returns seems to be „inflating or
deflating the future cash flows‟-and it is followed by theuse of „sensitivity analysis‟.
Most of the executives (around 75%) appreciate the suitability ofthe DCF technique in
our country.40
Jain P K and Kumar M (1998) has done a comparative study of capital
budgetingpractices in Indian context and observed that 25% of sample companies
invested forexpansion and diversification and firms were making regular investments
for replacementand maintenance.
39
Rao Cherukuri U (1996); Capital budget practices: A comparative study of India and select
South EastAsian Countries, ASCI Journal of Management, Volume 25, pp 30-46
40
C PrabhakaraBabu and Aradhana Sharma; Capital budgeting Practices in Indian Industry,
ASCI Journalof Management, Volume 25, 1996
The selected sample companies preference for evaluating capitalbudgeting projects
were PBP, due to its simplicity, easy understanding, less cost and lesstime, followed
by NPV and IRR. Companies preferred WACC followed by „Arbitraryrate‟ and
„Marginal cost of additional funds‟ as cutoff rate for discounting the projects.For

24
adjusting risk, the „sensitivity analysis‟ was preferred followed by „Higher cut offrate‟
and „Shorter Pay Back Period‟.41
AnandManoj (2002) surveyed 81 CFOs of India to find out their corporate
financepractices vis-à-vis capital budgeting decisions, cost of capital, capital structure,
anddividend policy decisions. It analyzed the responses by the firm characteristics like
firmsize, profitability, leverage, P/E ratio, CFO‟s education, and the sector. The
analysisreveals that practitioners do use the basic corporate finance tools that the
professionalinstitutes and business schools have taught for years to a great extent. It is
also observedthat the corporate finance practices vary with firm size. As per his
findings, the firms useDCF techniques more than before. They use multiple criteria in
their project choicedecisions. 85% of the respondents consider IRR as a very
important/important projectchoice. About 65% of the respondents always or almost
always use NPV. The PBPmethod is also popular. Large firms are significantly more
likely to use NPV than smallfirms. Small firms are more likely to use PBP method
than large firms. High growth firmsare more likely to use IRR than the low growth
firms. The sensitivity analysis andscenario analysis are most widely used techniques
for assessing the project risk.42
Gupta Sanjeev, BatraRoopali and Sharma Manisha (2007) has made an
attempttoexplore which capital budgeting techniques is used by industries in Punjab,
and theinfluence of factors such as size of capital budget, age and nature of the
company, and
education and experience of the CEO in capital budgeting decisions. They conducted
aprimary survey of 32 companies in Punjab. Almost one-third of the companies had
capitalbudget exceeding Rs. 100mn. Majority of the sample companies still use non-
discountedcash flow techniques like PBP and ARR. Only a few companies use DCF,
and amongthem very negligible number use NPV technique to evaluate a new project.
The mostpreferred discount rate is WACC. The most popular risk incorporating
technique is„Shorter PBP. Many companies feel that CEO education and experience
play animportant role in selecting the capital budgeting technique. Further, The study
did notfind any significant relationship between the size of capital budget and capital
budgetingmethods adopted. Similarly, though at some instances it appears that young
companiesprefer DCF techniques than the older ones, the same is not true in case of
NPV method.Thus, age of the company also does not influence the selection of the
capital budgetingtechnique. Similarly no significant relationship could be established
between the nature ofindustry and investment evaluation techniques.43
41
Jain P K and Kumar M (1998), “Comparative Capital Budgeting Practices:The Indian
Context”,Management and Change, January-June, pp. 151-171
42
ManojAnand; Corporate Finance Practices in India: A Survey; Vikalpa; Vol. 27, No. 4,
October-December 2002, pp. 29-56
43
Gupta Sanjeev, BatraRoopali and Sharma Manisha,”Capital Budgeting Practices in Punjab-
basedCompanies, The Icfai Journal of APPLIED FINANCE, February 2007, Vol. 13, No.2,
pp. 57-70
Nerlov (1968), found the factors influencing return of the scrip by taking 800
companiesfrom the Standard and Poor index with the span of 15 years. The factors
were identifiedby the study such as sales, retained earnings and growth in earnings
were regressed withreturn of the scrip for the purpose of witnessing the influence of

25
such factors on thereturn and it was found that dividend and leverage had strong
influence on market returnin long run whereas asset growth, inventory turnover, cash
flows and liquidity did notexert any influence on the return of the scrip. It seemed that
those variables were provedto be redundant.
Beaver and Others (1970) made an attempt to find out the sources of factor which
wasabout to influence the systematic risk .The study met out the purpose by way
ofidentifying the key explanatory variables such as dividend payout, growth,
financialleverage, liquidity, size, earning variability and earning beta. The study tested
thevariables with the help of cross sectional tests and found out the leverage and
accountingbetas were positively correlated and in similar way earning variability and
payout havesignificant correlation as per the expected direction. However, the size
exhibited aweaker correlation. The study used a sample of 307 firms, from CRSP
Tape, for whichcomplete accounting and stock prices data were available for the
period of 1945-1965.
Blume (1971), Levy (1971) and Levitz (1974) have suggested that the portfolio betas
were more stable than individual security beta. They also found that the assessment of
future risk was more reliable in large portfolio comparing to smaller portfolio, and for
individual securities the beta values were not reliable in terms of period. Lengthening
theperiod, say for example 13 weeks to 26 weeks regressed value are less reliable than
26weeks to 52 weeks. In summary they concluded that minimum intake of 25
portfolio andlarger with forecast intervals of 26 weeks and larger, past beta may be
taken as proxy topredict future beta co-efficient.
Baesel (1971) showed that the individual security betas were stable on the ground
ofincreasing the length of estimation period. He proved that beta stability has shown
moreimprovement when the estimation period was larger.
Sharpe & Cooper (1972) produced evidence in terms of stability with respect
toindividual security betas by way of taking US samples from 1931 to 1967 with the
helpof applying transition matrix approach and concluded that individual security
betasshowed stability over the period of time.
Black, Jenson and Scholes (1972) took an effort to investigate the stock market as an
efficient and the purpose for which they took the all scrips of New York Stock
Exchangeand divided into ten portfolios with the span of 35 years. The study found
that higherrisk portfolios fetched higher return and further they found that the stocks
those ofbelonging to the category of lower risk were undervalued whereas the stocks
those ofbelonging to the category of higher risk were overvalued.
Meyers (1973) came out with additional proof on the stability of individual
securitybetas by taking 15 years period from the year 1952 to 1967 and they found the
betaswere stable for at least seven years and proved beyond the doubt that the
individualsecurity betas were also stable by discounting the earlier assumptions of
individualsecurity beta.
Ben and Shalit (1975) made an attempt to find out the relationship between the firm
riskand its leverage, size and payout ratio. The study analyzed 1000 large companies
listedin the fortune directory in the year of 1970.The study found that the relationship

26
by wayof applying multiple regression. The result showed that the firm size, leverage
andpayout ratio were found to be significant determinant of equity risk.
Barry & Wicker (1976) came out with the result that apart from the factor such
asnumber of portfolio and duration of sub-periods influencing beta stability, the
changingcharacteristics of the firm like capital structure, business policy marketing
strategy andeconomic environment has also made an impact in determining the
stability of beta.
Gooding & O’Malley (1977) worked out correlations between the portfolio betas
byway of taking 200 samples from US during the period of 1966 to 1974. The
portfoliobetas were found in different market phases and the extreme portfolio betas
were eitherhigh or low exhibiting significant instabilities.
Basu (1977) found in the study of 1400 Industrial Firms from the Compustat File
ofNYSE during the period from September 1956 to August 1971, the stocks with
lowprice- earning ratios had higher average returns than stocks with high price-
earningratios.
Roenfeldt, Griepentrag and Pflown (1978) made an investigation in finding the beta
stability by way of dividing sub-period at different time interval. They took a sample
of644 firms with the price data for the period 1963 to 1974. They first made an
attempt inestimating the beta co-efficient for the period 1963 to 1966. They gave
ranking on thebasis of beta coefficient and then the firms were grouped. Further they
estimated the betafor the rest of the period in such a way of taking different sub-
periods from one year tofour years such as 1967 -68, 1967-69, 1967 -1970 & 1967 –
71. By way of analyzing theabove data they found the beta was more stable when it
was compared with previousfour year periods than one year period.
Fabozzi& Francis (1978) showed that beta was a random co-efficient. Because of
theabove reason New York stock Exchange (NYSE) had less than 50% of the
riskexplained by the market forces. The OLS estimate of beta was invariant over the
timewhile the beta moved randomly.
Alexander &Chervary (1980) showed the result against Baesel to prove that
theextreme betas were less stable compared to interior beta. They also contradicted
the viewof Baesel that longer the period would increase the beta stability. They put
forth theresult in such a way that not only the period determined the stability of beta
but also thebeta was determined by the magnitude of portfolio.
Chen (1981) tested if any relation was existed between variability of beta co-
efficientand portfolio residual risk. By way of analyzing the relation, he came out
with theconclusion that OLS method was not appropriate to estimate portfolio
residual risk ifbeta co-efficient changed over the time and further he stressed that it
would lead toincorrect conclusion.
Theobald (1981) showed that the stability of beta was a function of time period
usedforestimation of beta. He also showed that the stability would however not
increaseindefinitely with length of estimation period.

27
Gupta (1981) investigated a large sample of 276 companies from Bombay,
CalcuttaandMadras Stock Exchanges over a 16 year period from 1961 to 1976
towardscharacteristics of the rates of return on equities in the Indian capital market
and the studyconcluded that the rate of return provided by equities are not satisfactory
since 20% ofthe returns for various holding periods were negative. The returns
provided a partialhedge against inflation and the fluctuations in returns even within a
year were largeenough to conclude that time had an important bearing on realized
return. The risk wasconsiderable even when investment was a part of a portfolio of
securities.
Gupta (1981) found share price data between the periods of 1960-76, a total 606
equityshares for one or more holding periods were taken into consideration, from
Bombay,Calcutta and Madras Stock Exchanges. The long term rates on equities were
found to beless than that of company deposits, debentures, long term bank deposits
and preferenceshares indicating that equities providing hedge against inflation were
found to beredundant and the study posed a question of doubt about the validity of
CAPM in Indiancapital market.
Eubank Jr. A.A and Zumwalt J.K. (1981) examined how far the forecast errors of
betapredictions were influenced by the length of estimation period, the length of
predictionperiod, the size of portfolio and the risk class of the security or portfolio.
The study usedthe concept of mean-square error to estimate the forecast error
measure. The meansquareerror took into account of bias, inefficiency and random
error which were used todetermine the source of forecast error. The result obtained by
the study revealed that asand when the length of the estimation period was increased
the accuracy in forecastingwas improved. Further, it was also observed in the study
that the size of the portfolio andthe risk class of either security or portfolio had an
impact on forecasting the stability ofbeta. From the above study, the concept of mean-
square error helped the researchers toestimate the forecast errors as much accurate as
possible.
Hawawini (1983) presented a model that explained the direction and size of changes
inbeta resulting from changes in sampling interval. He reported that as the interval
islengthened, beta of thinly traded stocks increased whereas betas of frequently
tradedstocks decreased.The study conducted by Masulis(1983) showed that the
relationship between the scrip‟sreturn and the corporate leverage. The study was
carried out by the researcher to find outthe impact of leverage on return of the scrip on
the basis of the fact that high leveredcompanies might tend to get an advantage over
the low levered companies by way ofavailing tax shield .The study concluded that the
higher levered companies had an betterimpact in terms of their scrip return.
Srivastava (1984) studied a cross-sectional study of 327 firms of Bombay
StockExchange for the year 1982-83. The study spotted that there was an association
betweenthe rate of dividend of a company and its market price of equity and high
dividend rateswere the cause for higher market prices of securities. The study did not

28
support the MMapproach of assumption „Dividend is irrelevant in terms of
importance in explaining therates of return in Indian context‟.
Bhole and Rao (1987) examined a study to identify and analyze the rate of return
onequity shares in India during the period 1953 to 1987 on 32 industries listed in five
stockexchanges in India. The study made an attempt to test the risk-return relationship
andfound that there was an association between the return and risk by way of taking
intoaccount of the return on nine financial and physical assets and further
estimationrevealed that the return on the aggregate market was commensurate with
the risk. It washighly variable over one year periods, but it decreased with increase in
holding period.
Sreenivasan (1988) empirically tested the validity of CAPM in India with
stockpricesof 85 firms selected from Calcutta and Bombay Stock Exchanges from the
period July1982 to October 1985. Economic Times Index of ordinary shares were
considered asmarket proxy and found that CAPM relationship was valid.In an attempt
to explore the relationship between the return and the beta, explained underCAPM
model, Yalawar(1988) made an attempt to study in Indian environment. Thestudy has
tested the excess returns version of the market model by way of considering
the monthly returns for 20 years from 1963 to 1982 relating to 239 stocks
regularlytraded in Bombay Stock Exchange. Further significance of the beta estimate
was testedwith the statistical approach to establish it to be explanatory variables for
securityreturns. The results extended the support for the applicability of CAPM and
could beregarded as good descriptor of security returns in the Indian equity market.
Sharma (1989), conducted a study to identify the factors influencing the
relativepricesof equity shares in Indian context by considering a sample of 30 cotton
textile units for aperiod of 1976 to 1980, based on Bombay Stock Exchange. The
study identified shareprice as dependent variable by transforming it into log linear
function and the variableslike dividend pay-out, growth, capitalization rate and size
were taken as independentvariables and by applying regression to find out the
influence of predictor variables onmarket price of equity, the outcome of the result
showed that the dividend payout,growth and size of the firm emerged as significant
variables.
In the study of Ramachandran(1989) he took 132 scrips of Bombay Stock
Exchangefrom January 1979 to December 1986 to test the validity of CAPM in Indian
market.Hefound that there was no evidence to prove that the model holds well in
Indian context .
Handa and Others (1989) conducted a study on the estimation of beta and
itsrelationship between the time intervals. The study further assessed the size of
theportfolio were sensitive to beta estimation. The study analysed the sample of data
whichwere taken from CRSP from the period of 1964 to 1982 and created 20
portfolios onwhich the effect was estimated. The study revealed that the estimation of

29
beta in terms ofindividual level and portfolio level showed substantial difference with
respect to timeintervals. Higher the time intervals showed that the portfolio betas were
more stable thanindividual betas.
The study conducted by Zahir (1992) to find out the possibilities of
influencingcertaininternal factors and external factors on market price of selected
scrips of Indian stockmarket. To carry out the study, the researcher took 140 scrips
from the period of 1985 to1987 span of two years. The identified external variables
were RBI security index,money supply and time factor whereas the internal factors
such as share price, bonusissue, growth in assets, earning per share, book value per
share, yield and variability inmarket price. The result showed that the model of
regression could explain theindependent variables to the extent of 67% in terms of
higher volatility stocks whereasthe same variables were explained by the model to the
extent of only 29% with respectto low volatility group of shares.
Philip R.DavesMichael.C and Robert A.Kundel (2000) examined the four
returnintervals and eight estimation periods to determine the usage of return intervals
andestimation periods to calculate beta. The study used four return intervals in the
form ofdaily, weekly, fortnight and monthly returns. The estimation period varied
from one yearto eight years from 1982 to 1989. As far as the outcome of the study is
concerned withrespect to return interval, for any given estimation period, the daily
return intervalprovided a more precise estimate of beta. The study also noted that
shorter returnintervals were associated with smaller standard error or greater precision
and in the sameway increasing the estimation period from one year to three years the
standard error kepton decreasing. However, regarding estimation period the study
posed a question ofreliability on estimation of beta. In some cases, the longer
estimation period alsowitnessed a significant change in the stability of beta. Hence the
study concluded that thelonger estimation period provided more of bias so that the
effect could be of less use forfinancial practitioners.
Chawla (2001) found that the hypothesis of stability of beta was rejected for
20companies out of 36 companies that he selected in a sample for the period of April
1996to March 2002.The study was attempted by Mohanty (2001) to find out whether
there was relationshipbetween the size of the company and the return generated by the
stock so that the studytested the stocks from small category as well as the large
category. The data werecollected from CMIE PROWESS data base spanning more
than 10 years indicated thatthe size of the company had an influence on return of the
scrip in negative way as suchthe larger the size of the company the smaller the return
generation and vice versa.
The study with respect to find out the possibility of presence of CAPM in Indian
contextby Mohamed and Devi (2004) explored the question of applicability in terms
ofpractical relevance and for which the study took the sample of 200 company scrips
fromBSE span of 12 years and the study found by using regression model that the
returngenerated by the scrips was equally to risk free rate and emphasized that
Sharpe-Linters‟CAPM is not relevant to Indian market.

30
Manickaraj&Loganathan (2004) used the sample of 38 stocks listed in the
BSEduring the year 1990 to 1996 and showed that the beta values were not stationary
over
the time.
Sehgal and Tripati (2005) examined the relationship between size and return of
thescrips on the basis of assumption that there was a relationship between the size of
thecompany and the return generated by the scrips .In their study they identified
different
proxies for size of the company. They took market capitalization, enterprise value, net
fixed assets, total assets and net working capital and used them as independent
variablesand market return of the scrips as dependent variable. With the help of
multipleregressions the study found that there was significant relationship between
scrip returnand company investment.
Bundoo S.K. (2006) investigated the systematic risk for the listed companies on
theStock Exchange of Mauritius. The study took into account of Capital Asset
PricingModel and Market model to estimate the time variation of beta. The study
made anattempt in investigating the time varying beta in thin trading session. The
result found
that the traditional beta estimates were different from the beta value of thin
trading.Byway of analyzing the above concept, the study brought to light the decision
taken interms of analyzing systematic risk, the role of thin trading became vital when
marketthemselves were characterized by thin trading. The study also revealed that
when timevariation in beta was taken into account the spread of systematic risk was
higher insmaller firms than in larger firms. The reason for higher systematic risk in
smaller firmsand lower systematic risk in larger firms was attributed to volatility in
the market to agreater extent.
Shijin and Others (2007) examined the risk-return characteristics of common
stocksinIndian stock market for the period from March 1996 to March 2006 for a
sample of 72companies from Bombay Stock Exchange. The results of Vector
Autoregressive Modelindicated that market risk proxy had persistent effects on stock
returns in Indian market.
Haddad (2007) explored the stability of beta in relation with the size of the
portfolio.The study segregated the portfolio of securities into two categories with one
of them inlarge size and other one in small size. The study took the sample of 18
companies fromtwo different stock indices from the Egyptian‟s stock market and
found that the volatilitywas persistent in terms of small portfolio whereas the large
portfolio did not show muchvolatility with respect to degree of return. The study
concluded that the effect size of theportfolio had an impact on the stability of beta.
Koo and Olson (2007) emphasized the non-viability of CAPM by way of taking
288sample of companies listed in the New York Stock Exchange. The study took
intoaccount of S & P 500 index as a proxy for market portfolio and found that this
market
model of beta was not relevant in measuring the market risk and thereby the
expectedreturn derived by way of including the market model of beta was no longer
applicable inthe New York Stock Market.

31
Singh (2008) examined betas of 159 stocks for the period 1991 to 2002 to study
thecomputational effects of the intervals between the data points, the time period
overwhich the beta is calculated and the size of the portfolio. Considerable variations
werefound according to the methods used for calculation.
The study conducted by Singla (2008) tried to examine the validity of CAPM in
Indianmarket in which he traced 320 scrips spanning of 6 years from BSE. The study
tested theconcept of CAPM such that the return mandated by CAPM depends on the
level of betaof the scrip. In this study it was found that higher level of return was
reflected withhigher level of risk resulted into the proof of validity of CAPM in Indian
market.
Kumar and Gupta (2009) made an attempt to investigate the pattern of volatility
inIndian stock market and to meet out the purpose they tested a sample of 29
companies
on the basis of daily closing price traded in NIFTY from the period of 1996 to 2007
withthe span of 12 years and they found that the companies taken for the study were
highlyvolatile.
Broca (2009) wanted to investigate the distribution of return with respect to
variousscrips in Indian context. The study made an attempt to explore the occurrence
of returndistribution in the form of normal or non normal with the help of normality
test. The testrevealed that the return distribution had more of non normal
characteristics resulted intosevere leptokurtosis and slight negative skewness.
Kapil and Sakshi (2010) made an attempt to explore the presence of validity
ofCAPMtheory in Indian stock market. In order to test the applicability of CAPM in
Indiancontext the study undertook the research in BSE 500 by identifying 278
companies andthe return of the companies were computed and the same return was
regressed withmarket return to arrive the beta value with which the association could
be ascertained interms of risk and return. The study found that higher risk was not
commensurate withhigh return indicating that the theory of CAPM was discounted in
Indian context.Similar study was carried out by Madhu and Tamimi (2010) to
investigate the validityof CAPM in Indian context by analyzing the drug industry
comprising 60 companiesfrom BSE during the period from 2001 to 2007. The result
of the study brought to lightthat there was a proof indicating that the theory of CAPM
was applicable in Indiancontext.
MazenDiwani (2010) put forth a study with respect to viability of CAPM in
emergingmarket in which the study selected India as one of the emerging markets and
tested thetheory in BSE by taking 28 companies during the period from November
2004 toOctober 2009.The study found that the question of applicability of CAPM in
Indianmarket was still alive.
KapilChowdhry (2010) tested the validity of CAPM for the Indian stock
market.Thestudy took 278 companies of BSE 500 from January 1996 to December

32
2009. In thisstudy, it was found that there was no support evidence in proving the
relationshipbetween higher risk and higher return. The study explored the reason for
portfoliocombination to mitigate the firm specific part of risk and thereby
diversification helpedto reduce the unsystematic risk. The result obtained by the study
proved to certain extentthat CAPM equation could be regarded as explanatory
equation of security returns. Asfar as CAPM is concerned, the intercept should
approach very close to zero and theslope should provide excess return on market
portfolio. But the study did not find thesupport of evidence on the ground of above
facts and in contrast there was evidence indisproving the viability of CAPM in Indian
context. In addition to that, the studyconducted the test to investigate whether the
CAPM captured all the aspects of reality byincluding residual variance of the stocks.
The result obtained by the test conducted forthe above same duration of the period did
not clearly reject CAPM. In the light of theabove findings, the study concluded that
beta is not sufficient to determine the expectedreturns on securities or portfolios.
SoumyaGuhadeb&SagarikaMisra (2011) found that there was evidence
ofinstability of betas especially in the shorter time period and the instability was
reducedwhen the beta estimation period increased. In addition to that the extreme
betas showedthe higher stability than the intermediate range of betas.
Murthy Jogalapuram (2012) found that among the various return interval
periods,halfyear return shows low risk and high return.
Balakrishnan&Rekha Gupta (2012) showed that most of the portfolio betas
werenotregressed to the value one and also they proved the individual securities beta
andportfolio betas are not related to each other.
Harish S.N. and T.Mallikarjunapa (2014) tested whether the betas were
stableacrossthe time or not. The study took data for 14 years from 2000 to 2014.
Three portfolioswere constructed to know the stability of beta. The study adopted the
Chow test toinvestigate the impact of sub prime crisis of 2008 on beta stability. The
structural breaktest showed that subprime crisis had an impact on 47% of the stocks
whereas 53% ofstocks did not undergo any impact on account of subprime crisis. By
using Chow test,the study additionally found that the portfolio betas were less
influenced in terms ofsubprime crisis compared to individual securities betas which
were influenced at highlevel. The study further explored with the help of WD max
and UD max and it wasfound that almost 70% of the betas had no structural break.
Since the individual stockencountered with higher structural breaks, the impact of
individual stocks on portfoliowas high. Hence the beta stability on portfolio was
somewhat adverse.
A.K.Dubey (2014) made an attempt in analyzing time scale dependence of
systematicrisk of stocks for an emerging market economy. The result of the study
showed thatthebetas were more or less instable in terms of different trading stocks at
differentinvestment horizons. The study was undertaken on the basis of the
characteristics of theheterogeneous investors with different investment horizons. In
this study, it was stressedthat holding different stocks by trading classes varied due to
the time horizon ofinvestment and perception of the risk. The study emphasized the
conditions of businessare very fluid i.e. the rate of change takes place in the phase of
organization as fast aspossible. By taking the above statement into account, the study

33
followed the assumptionof the dynamic risk which is having more of association with
developed market. Thesame assumption will not hold true in the emerging economy
like India. The studyrevealed that time scale dependent estimates of systematic risk
embedded in differentstocks and the tools used in the study will give insight to the
practitioners‟ while portfolio planning.

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