Lawrence D. Schall (Professor of Finance and Business Economics, University of Washington) Gary L. Sundem (Associate Professor of Accounting, University of Washington) William R. Geijsbeek, Jr. (Finance Manager, The Boeing Company)

1. Survey and Analysis of
Capital Budgeting Methods
Submitted to:
Prof. Dr. Ramji Gautam, and Prof. Dr. Rajan Bahadur Paudel.
Submitted by:
Raju Basnet Chhetri
8 May 2020
A Synopsis on

2. Description of the Article
Title:
• Survey and Analysis of Capital Budgeting Methods
Authors:
• Lawrence D. Schall (Professor of Finance and Business Economics, University of
Washington)
• Gary L. Sundem (Associate Professor of Accounting, University of Washington)
• William R. Geijsbeek, Jr. (Finance Manager, The Boeing Company)
Journal:
• The Journal of Finance, Vol XXXIII, No. 1, March 1978, pp. 281-287.

3. Background
• A Survey by Istvan (1961), Klammer (1972), Fremgren (1973) studied on capital
budgeting methods and concluded that firms are using increasingly
sophisticated capital budgeting techniques.
• The study puts an attempt on updating of such previous studies.

4. Research Gap/Motivation
• The motivation of the study is to assess the recent use of capital budgeting
techniques as an extension of previous research studies.

5. Purpose of the study
1. To find the capital budgeting techniques employed in practice,
2. To explore the computation of discount rate and of cash flows,
3. To identify the method of estimating and adjusting for project risk.

6. Methodology (1/2)
• The study is based on quantitative approach with data collection
by survey.
• The sample size was 407 firms ( due to elimination of 17 firms
from 424 proposed sample) taken from COMPUSTAT tape.
• There were 189 responses with 46.4% response rate.
• As a control of response bias, 16 non-respondents were
randomly called and results analyzed from the responses
obtained from 15 of them. Such firms were slightly sophisticated
in capital budgeting methods and slightly less sophisticated in
risk assessment methods evidencing no significant presence of
response bias.
Data
Collection

7. Methodology (2/2)
• The study uses descriptive statistics like percentage and
frequency distribution for analysis.
• Similarly, the correlation of size of the firms and risk with
sophistication variables was performed to identify some firm
characteristics that might be associated with added
sophistication in capital budgeting techniques.
Tools

8. Results of Survey (1/3)
• Almost 86% of the firms use more than one of the CBTs (PBP,
ARR, IRR, NPV), with 17% using all four.
• The most popular CBT is PBK used by 74%. ARR is used by 58%,
IRR by 65%, and NPV by 56%.
• Over 86% used either IRR or NPV or both.
Capital
Budgeting
Techniques

9. Results of Survey (2/3)
• 46% employ WACC (one third use it in combination with other
methods) and only 8% use a risk-free rate plus a premium for
their risk class.
• After tax discount rate is used by 88% for after tax cash flows.
• The average after tax rate is 11.4% and before tax rate is
14.3%.
• 7% indicated that they used net income directly.
• 18% indicated that they predict cash flows directly.
Calculation
of the
Discount
Rate and
Cash Flows

10. Results of Survey (3/3)
• Over 36% use a quantitative assessment of risk, 4% do not assess
risk, and remaining 60% assess risk only subjectively.
• 23% assign projects to risk classes, and remaining 77% don’t.
• 25% assess project risk by means of probability distribution of
cash flow.
• 10% responded they use sensitivity analysis through open ended
questions.
• 4% calculate covariance of project’s cash flows with cash flows
of other projects.
• Over 57% either ignore risk or assess project riskiness
subjectively.
Risk
Assessment

11. Major Findings
• 57% of the firms using discounting methods (IRR or NPV) (Klammer, 1970) rose to
86% during the study.
• 78% of the firms adjust the capital budgeting techniques for risk by use of
sophisticated methods which was done by 39% of the firms in 1970 (Klammer,
1970) and 67% of firms in 1973 (Fremgren, 1973).
• Analysis of the characteristics of size and risk with sophistication variables
indicated that larger firms use more sophisticated techniques.
• Slight tendency was found for market assessed risk (beta value) to be negatively
associated with sophistication in risk assessment techniques.

12. Limitations
• The sample consisted majorly large firms. Hence, results can’t be generalized
to small firms.

13. Conclusion
• The use of sophisticated capital budgeting techniques is in increasing trend.
• After-tax weighted average cost of capital is common method of determining a
required rate of return.
• Project risk is usually assessed subjectively by major number of firms.
• Most firms require higher rate of return for more risky projects.
• The sample under study gives thin evidence that the level of sophistication in
capital budgeting methods is directly related to the firm’s capital budget size
and inversely related to the firm’s beta value.

14. Reflection from the article
• This is the first article I have encountered with authors from both academic and
practitioner background. Consequentially, the results are useful for both
academicians and practitioners.
• Similarly, the study has beautifully interpreted the results of the survey even by
use of simpler of statistical tools.
• Very simply put, it gives the foundation of understanding of use of capital
budgeting techniques in practice and how firms assess risk.

15. Thank you
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