1. 1
COURSE TITLE: SEMINAR IN FINANCE COURSE CODE: MPH 622
Synopsis of articles: Survey and Analysis of Capital Budgeting Methods
By Prof. Lawarance. D. Schall, Prof. Gary L. Sundem and William R. Geijsbeek, Jr.
University of Washington and Finance Manager, The Boeing Company
Submitted by: Sudarshan Kadariya, Roll No 04/’010, M. Phil II Semester
Motivation: The accounting and finance literature have growingly indicated that firms are using increasingly sophisticated
capital budgeting techniques (CBTs) in practices, with this respect authors from the academic and practitioner field
motivated to conduct the study.
Objectives: The aims of the study are concentrated into three different areas, as i) capital budgeting techniques employed
in practices, ii) computation of discount rates and cash flows and iii) the method of estimating and adjusting for project risk.
The stated objectives are discussed and find out the popularity of them based on the study of the sample.
Statistical tools used for the analysis: The study uses the naïve methods for analysis and interpretation of the results.
Frequency distribution, range and percentile are adopted for the study purpose.
Population: Population considered as large US firms and included on the COMPUSTAT tape.
Sample: Selection of sample constitute the fulfillment of the condition, all the included firms (424) were from the
COMPUSTAT tape with i) net plant assets exceeding $200 million, ii) capital expenditures exceeding $20 million, or iii)
net plant assets exceeding $150 million and capital expenditures exceeding $10 million. Because of the 17 firms either
merged or their mailing address unattainable, only 407 firms are considered for the further survey.
Respondents & response rate: Major financial officers are the respondents and questionnaire were sent to them (407 FOs)
and the response rate was 46.4%. Despite the biasness as considering toward large stable firms, further characteristics of
the firms are – respondents were statistically larger than the non respondents, had smaller variances of shareholder rate of
returns, had lower variation of net income, and had smaller beta values. The response bias does not appear to be a major
factor, since it is tested and certain levels of biasness also appear in the similar kinds of study.
Variables: Payback period (PBK), accounting rate of return (ARR), internal rate of return (IRR) and net present value
(NPV) are considered as the major study variables and cost of debt, cost of equity, weighted average cost of capital
(WACC), growth and dividend payout ratio, risk-free rate are also used for the analysis.
Findings: The results of the analysis with respect to the objectives of the study are as follows.
i) Almost 86% of the firms use more than one capital budgeting technique.

2. 2
ii) The most popular technique is PBK (74%), followed by IRR (65%) and NPV (56%) is least preferred technique.
iii) The use of IRR or NPV or both techniques constitute over 86% and only 16% use one or both without using ARR
and PBK.
iv) About 41% FOs use CBTs for all investment decisions while 59% use them for certain type of investment
decisions.
v) The average firm uses CBTs for 82% of its investment decisions and 20% of the firms use CBTs only for large
investment i.e. over $100,000.
vi) WACC is one of the most popular discount rate among the large US firms.
vii) After tax discount rate is used by major firms (88%) and the average rate 11.4% compare to before tax average
discount rate 14.3%.
viii)The most common method of predicting cash flow is predicting net income (NI) first and adjustment of non-cash
flow items.
ix) Majority (60%) of the respondents use the subjective judgment for risk assessment where as 36% use quantitative
assessment of risk and only 4% of the respondents do not assess the risk.
x) Individual project risk evaluation is based on over 57% as subjective evaluation, followed by probability of cash
flow and sensitivity analysis and covariance of cash flow with other projects respectively.
Conclusions: The literature starting Klammer (1972) and Fremgren (1973) on CBTs shows the increasing trend of using
capital budgeting techniques for the investment decision making. Former showed 39% and later 67% of the decision based
use CBTs in their study, further Lawarance, et.al (1977) found 78% as the parameter of popularity. The study on top of the
previous, suggest that 86% of the firms use more than one capital budgeting technique. After-tax WACC is the most
common method of determining a required rate of return. Project risk is usually assessed subjectively and there is evidence
that the level of sophistication in CBTs is positively related to the size of the firm’s capital budget and negatively related to
risk.
Comments: Authors presented the essence of the study in a simpler ways, the findings could impart to everybody as the
importance of CBTs and its pervasive use from the very beginning. The results of the study are very much useful to the
learners and beginners (practitioners). The study was conducted by the authors from the academic and practitioner field of
finance, thus it is an interesting blend of two opponents.
***