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Military-Madrasa-Mullah Complex 339
India Quarterly, 66, 2 (2010): 133–149
A Global Threat 339Article
An Empirical Insight into Different Stages of Capital Budgeting
Roopali Batra Satish Verma
Abstract
In today’s highly turbulent and volatile business environment where companies are exposed to a multitude of risks, only globally competitive and professionally managed companies can thrive and grow. In such a competitive environment, the capital budgeting decisions made by a company are critical to a firm’s long-term survival. Is the Indian corporate sector using theoretically sound and sophisticated capital budgeting techniques for decision making purposes? Are the Indian firms adopting risk analysis techniques for handling various risks in investments? These issues have been the focus of research studies over the past so many years. The most prevalent emphasis of previous capital budgeting surveys continues to be mainly on financial analysis and project selection stage of capital budgeting.
The article reviews the past capital budgeting survey literature till the year 2012 and brings to light some of the neglected areas of capital budgeting. It is noticed that project definition and cash flow estimation (identification and development) (Stage I), project implementation (Stage III) and project review (post audit and control) (Stage IV) are the specifically neglected areas of the capital budgeting process. Further Indian studies encompassing the overall stages of capital budgeting process still remain relatively unexplored. The main aim of the present study is to not only provide an insight on the past literature, but also explore the CFOs opinions and perceptions about the relative difficulty and signifi- cance of different stages of capital budgeting in India, particularly in an era of full-fledged globalization and cutthroat competition, where companies are being exposed to various degrees of risk. The study is based on a primary survey of CFOs of 77 Indian companies listed on Bombay Stock Exchange. The study further endeavours to evaluate the impact of different company related variables of size of capi- tal budget, nature of industry, company age, CEO education and CEO age on the level of difficulty of different stages of capital budgeting.
Keywords
Capital budgeting, stages, project definition, cash flow estimation, financial analysis, project selection, project implementation, project review, riskiness, importance, difficulty
Roopali Batra, Faculty in Management, Apeejay Institute of Management Technical Campus, Rama Mandi, Jalandhar - 144007, Punjab. E-mail: [email protected] Satish Verma, Professor, RBI Chair, Centre for Research in Rural and Industrial Development (CRRID), Sector 19-A, Madhya Marg, Chandigarh - 160019. E-mail: [email protected]
Global Business Review 15(2) 339–362
© 2014 IMI SAGE Publications
Los Angeles, London, New Delhi, Singapore,
Washington DC DOI: 10.1177/0972150914523588
http://gbr.sagepub.com
Global Business Review, 15, 2 (2014): 339–362
340 Roopali Batra and Satish Verma
Introduction
Financial management today, is largely concerned with financing, dividend, liquidity and investment decisions of the firm aimed at achieving the overall corporate goal of maximizing the market value of the firm to its shareholders.
The shareholder wealth maximization goal states that management should endeavour to maximize the net present (or current) value of the expected future cash flows to the shareholders of the firm. Thus capital budgeting plays a fundamental role in any organization’s financial management strategy. Each and every business organization that carries out this process must ensure that their investment decision making criteria supports the business’s strategy and enhances its competitive advantage over its rivalries. Capital budgeting decisions have a long range impact on the firm’s performance and they are highly critical to the success or failure of any firm.
A past review of the capital budgeting survey literature shows that the focus was mainly on financial analysis and project selection stage of capital budgeting, ignoring the others. Several researchers such as Gordon and Pinches (1984), Scott and Petty (1984) and Mukherjee (1987) have specifically pointed to these ignored areas. In the Indian context also, the same trend is seen. A review of Indian studies reveals that virtually scant research has been done, encompassing the different stages of capital budgeting. The present study is an advancement in this ignored area. The first and foremost objective of this article is to analyze the importance, difficulty and riskiness of different stages of capital budgeting process based on a survey of 77 CFOs of a number of carefully selected companies listed on the Bombay Stock Exchange (BSE). Another objective is to evaluate the impact of different company related variables of size of capital budget, nature of industry, company age, CEO education and CEO age on the level of difficulty of different stages of capital budgeting. This article not only adds to the existing aca- demic research on capital budgeting in India, but also brings to light the ignored aspects of studies of capital budgeting in India.
The article is organized as follows: The first section discusses the theoretical framework of different stages of the capital budgeting process. The second section is of review of literature, in which previous researches conducted on this topic have been addressed. The third section deals with the need, objectives and hypotheses of the study, In the next section, that is, the fourth section, database and research methodology are discussed, after which the empirical results are presented and evaluated in the fifth section, data analysis and results; and, the last sixth section presents the findings, conclusions and insights for future survey research.
According to (Mukherjee, 1987), capital budgeting can be viewed as a process that requires several tasks to be performed at different phases. It is a multi-faceted activity and a loopy process with several sequential stages in the process. These stages are:
1. Strategic planning—Strategic planning can be defined as an organization’s process of defining its strategy or direction and making decisions on allocating its resources to pursue this strategy.
2. Identification of investment opportunities—Profitable investments emerge from healthy suggestions, so the firms should develop a mechanism wherein the investment suggestions coming from inside the firm, such as from its employees or from outside the firm, such as from a firm’s advisors are ‘listened and paid attention to’ by the management.
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Different Stages of Capital Budgeting 341
3. Preliminary screening of identified projects—To avoid unnecessary wastage of resources such as time, money and effort, these identified investment opportunities are subjected to a preliminary screening process by the management so as to isolate the marginal and unsound proposals.
4. Financial appraisal of screened projects—This involves a detailed analysis of the marketing, technical, financial, economic and ecological aspects of these projects. Financial appraisal involves the application of cash flow forecasting techniques, project evaluation or capital budgeting techniques, risk analysis techniques and even mathematical programming techniques.
5. Consideration of qualitative factors in project evaluation—This includes factors such as societal impact on employment, environmental impact, safety issues, political attitude towards the project, labour management relationships and legal hassles of the project.
6. Final accept/reject decision of projects—Finally acceptation or rejection of projects is done on the basis of all collected information coming from the financial appraisal and qualitative results and data, as well as the managers’ judgement.
7. Project implementation—The implementation phase of the project involves setting up of manufacturing facilities, project and engineering designs, negotiations and contracting, construction and training and plant commissioning is done.
8. Post-implementation audit/project review—Project review helps in providing useful feedback to project appraisal or strategy formulation by analyzing the past ‘rights’ and ‘wrongs’.
Review of Literature
Pinches (1982) applied the Mintzberg et al. (1976) four-stage model to capital budgeting. These stages are (i) identification of an investment opportunity, (ii) development of an initial idea into a specific proposal, (iii) selection of a project and (iv) control, including post audit, to assess forecast accuracy. Corresponding to this, the majority of studies on capital budgeting have used the same names for the subsequent stages. Thus for the purpose of review of survey literature on different stages of capital budgeting, the studies have been discussed below.
Istvan’s (1961) found that nearly 60 per cent of investment proposals were originated by operating personnel, not top management. Mao’s (1970) indicated that financial executives were not project originators and packaged plans were forwarded from departments to financial managers for evaluation. Petty et al. (1975) reported that new proposals generally flow from the lower managerial levels. Williams (1970) found that engineers and accountants are more involved in pre screening than personnel in finance. Schall et al. (1978) reported that the 62 per cent firms used cash flow as the relevant data, with the most commonly used definition of cash flow being net income plus depreciation. Pruitt and Gitman (1987) and Pohlman et al. (1988) provided a deeper understanding of capital budgeting forecast biases and cash flow estimations.
The most frequently investigated aspects of capital budgeting that have received the most emphasis are the investment appraisal techniques used, techniques of risk assessment and the methods of calculat- ing cost of capital. The studies in foreign reveal that the majority of firms have adopted sophisticated Discounted Cash Flow techniques (DCF) techniques and DCF analysis has become a standard practice. (Gitman and Forrester, 1977; Kim and Farragher, 1981; Klammer, 1972; Klammer and Walker, 1984; Oblak and Helm, 1980; Petty et al., 1975; Schall et al., 1978). The Internal Rate of Return (IRR) is the
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342 Roopali Batra and Satish Verma
favoured over Net Present Value (NPV) (Cherukuri, 1996; Fremgen, 1975; Klammer and Walker, 1984). Babu and Sharma (1995) observed that DCF methods were applied by 75 per cent of the Indian companies. However, Jain and Kumar (1998) observed that in India still the most preferred method was Payback Period Method followed by NPV and IRR. Graham and Harvey (2001) and Ryan and Ryan (2002) revealed that the firms which are large, with high debt ratios, having CEOs with MBA are significantly more likely to use DCF techniques such as NPV and IRR than their counterparts. Anand (2002) surveyed 81 Indian CFOs and found that IRR and NPV being the most popular techniques. Chen (2008) observed that firms with high product standardization were found to place more emphasis on DCF analysis. Researchers have observed an increasing preference for non-discounted capital budgeting techniques (Gupta et al., 2011). Singh et al. (2012) found that despite the theoretical superiority of NPV, Indian firms indicated a preference for IRR over NPV.
A number of research studies have highlighted that firms explicitly consider risk in analysis of capital investments (Gitman and Forrester, 1977; Klammer and Walker, 1984; Petty et al., 1975). The most popular risk-adjustment techniques were always found to be risk-adjusted discount rates (or raising required rates of return) and shortening of the payback period. However sensitivity analysis, a more sophisticated risk analysis tool has gained wide popularity in the recent years (Babu and Sharma, 1995; Cherukuri, 1996; Gitman and Mercurio, 1982; Jain and Kumar, 1998; Kim and Farragher, 1981; Klammer and Walker, 1984; Petry, 1975). Graham and Harvey’s (2001) survey found that large firms are more likely to use risk-adjusted discount rate while small firms prefer Monte Carlo simulation for risk adjustment. The most popular methods for risk incorporation included sensitivity analysis and scenario analysis (Anand, 2002; Ryan and Ryan, 2002; Singh et al., 2012). Another notable finding was the emergence and usage of new techniques of real options and abandonment options an encouraging indication of growing professionalism in companies (Bennouna et al., 2010; Singh et al., 2012). The results were in sharp contrast with Graham and Harvey (2001) and Block (2005) who found a very low usage of real options.
Surveys suggest that the use of the weighted average cost of capital (WACC) as a hurdle rate has increased significantly over the years, especially since the late 1970s. Christy (1966), Williams (1970) and Petty et al. (1975) reported a usage of WACC by less than 30 per cent of the firms. Later studies by Schall et al. (1978), Oblak and Helm (1980) and Gitman and Mercurio (1982) evidenced a substantial increase in the use of WACC (up to 83 per cent). Gitman and Mercurio (1982) observed that nearly 17 per cent of respondents employed the cost of specific source of funds as a cut off rate (almost 90 per cent of these firms were in Fortune’s second 500); 66 per cent used current costs of similar obligations, while the remaining 34 per cent used historical contractual cost. The majority of respondents measured the cost of equity as the return required by investors. The most widely accepted and popular discount rate was WACC (Anand, 2002; Babu and Sharma, 1995; Bierman, 1993; Cherukuri 1996; Irala, 2006; Jain and Kumar, 1998; Ryan and Ryan, 2002). Graham and Harvey (2001) found that, while small firms calculate cost of equity by what investors tell they require, large companies are more likely to use capital asset pricing model (CAPM) for the same. Further CAPM was found to be the most popular to calculate cost of equity capital (Anand 2002; Gitman and Vandenberg, 2000; Irala, 2006; Ryan and Ryan, 2002).
Studies by Gitman and Mercurio (1982), Gitman and Forrester’s (1977) and Oblak and Helm (1980) studied project approval and their acceptance. Luck et al. (1971) found that even if submitted projects were turned down, they were recycled and eventually accepted. Gitman and Vandenberg (2000) observed that firms employed more formal processes for project approval, especially for large outlays.
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Miller (1960), Istvan (1961) and Williams (1970) found that the majority of firms had post audits and follow up procedures and employed ROI to evaluate performance. Klammer and Walker’s (1984) results further documented an increasing use of such audits. Rosenblatt’s evidence (1980) focused on incentives in the review stage. Neale (1994) observed that on an average US companies have a higher post-audit adoption rate than the UK companies.
Further surveys have also been conducted covering the different stages of capital budgeting and analyzing the relative degree of difficulty or importance associated with each stage. Hall (2000) in his survey found that the most important, most difficult and most risky stage in the capital budgeting process was project definition and cash flow estimation. Financial analysis and project selection was found to be relatively less difficult and less important. The project implementation and project review stages were viewed by most companies to be relatively unimportant and not difficult, although companies did regard project implementation to involve some risk. Gitman (2007) explained that the capital budgeting process consists of five distinct but interrelated steps, namely proposal generation, review and analysis, decision making, implementation and follow-up. Brijlal and Quesada (2008) studied capital budgeting practices of businesses in Western Cape in South Africa and found that project definition was the most important stage across all sectors and sizes, followed by financial analysis and selection. However, project defini- tion and financial analysis and selection were the most difficult stages followed by implementation. The implementation stage appeared to be the most difficult stage for the manufacturing sector. Hall and Millard (2010) in their study of 67 South African industrial firms listed on the JSE Securities Exchange observed that project definition and cash flow estimation and project implementation are the most impor- tant and the most difficult stages. Financial analysis was regarded as the second most important, but not as difficult. Project review and follow-up were given a low rating. Later Hall (2000), who found that the project definition and cash flow estimation were considered to be significantly more risky (46.2 per cent) than any other stage. However, there seems to be a marked increase in the risk consideration that espe- cially the project implementation stage carries. The fact that the financial analysis was considered to be relatively less risky could arise from the fact that the respondents are academically well educated with a high level of experience and are therefore at ease with the actual financial calculations and analysis of the project.
It reveals that most of the researchers have studied what techniques firms used in their Stage 3 (selection) processes. The financial analysis and selection stage, with its emphasis, in particular, on project evaluation techniques, have always dominated the survey topics over the entire review period. The other stages of project identification or definition, cash flow estimation, project implementation and last but not least project review or control and post audit, which were found to be the most unexplored areas of capital budgeting. Many researchers have highlighted this issue like Kim (1979) who observed that ‘too much emphasis was being placed on methods of ranking and selecting capital budgeting proposals’. Similarly Scott and Petty (1984) commented that ‘disproportionate (unjustified) amount of time spent (has been) on a particular stage of financial analysis and project selection’. Later, Gordon and Pinches (1984) generalized this objection by stating that ‘the capital budgeting process must be viewed in its entirety.’ However, some quality survey research efforts into these neglected areas include cash flow estimation by Pruitt and Gitman (1987) and Pohlman et al. (1988), the reasons for usage of investment evaluation techniques by Burns and Walker (2009) and studies on capital rationing by Mukherjee and Hingorani (1999). Further researches on cost of capital practices were made by Bruner et al. (1998) and by Gitman and Vandenberg (2000) and the investigation of risk analysis practices were made by Trahan and Gitman (1995) and by Graham and Harvey (2001). Similarly studies were made by
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344 Roopali Batra and Satish Verma
Gordon and Myers (1991) and Myers et al. (1991) on the control (post-audit) stage. However, the majority of this notable progress was made in capital budgeting survey research of US firms and that also till 2002. This was later followed by a complete decline after 2002 on these issues. Similarly some of the academic surveys by Sangster (1993), Pike (1996) and Arnold and Hatzopoulos (2000) of large European firms focused on some neglected areas of risk analysis, cost of capital, capital rationing and post- completion audits. Thus, European surveys also did make only very minor contributions to the neglected areas just like their US counterparts.
An analysis and review of past Indian capital budgeting survey literature reveals similar findings, that is, lack of research on the above mentioned neglected areas. The focus of prominent Indian researchers Dhankar (1995), Jain and Kumar (1998), Bhattacharya (1997) and Anand (2002) were all on the finan- cial analysis and selection stage with emphasis on capital budgeting techniques, risk analysis techniques or cost of capital techniques. The other stages of the capital budgeting process have not received their due significance in Indian capital budgeting literature. Very few Indian studies like by Chandra (1975), Porwal (1976), Babu and Sharma (1995), Jain and Kumar (1998) and Bedi (2000) studied the Origination and Screening of Investment proposals. Some studies by Porwal (1976) and Cherukuri (1996) also focused on the Post Audit and Control stage. Research studies have even studied a little of the capital rationing aspect like by Porwal (1976) and Pandey’s (1991). Later Cherukuri (1996) and Bedi (2000) also found significant upward trend in the use of capital rationing. A recent study by Singh et al. (2012) has also focused on issues of origination and planning of capital investment proposals, capital rationing, real and abandonment options, investment pattern, etc. A brief glimpse of these studies show a very little effort on the part of Indian researches to investigate the other neglected stages of capital budgeting.
Objectives of the Study
An in depth analysis of past review reveals that researches in the area of capital budgeting in India have either studied the financial goals or capital budgeting techniques or all areas of corporate finance. Further emphasis was largely on the financial analysis and project selection stage.
Though some studies encompassing different stages of the capital budgeting process have been conducted by foreign researchers, the review of literature depicts the dearth of any study in India focusing on the relative importance and difficulty of different stages of capital budgeting.
The present study is a step in this direction. The main aim of this study is to identify neglected areas of capital budgeting and further move to reveal the perceptions and opinions of Indian CFOs about the different stages of capital budgeting.
The specific objectives of this study are:
• To have an insight into the past capital budgeting survey literature to identify the neglected areas of capital budgeting.
• To study CFO’s opinion about the relative level of importance, difficulty and riskiness of different stages of capital budgeting.
• To study the impact of different company related variables/firms specific attributes like size of company’s capital budget, nature of industry, company age, CEO education and CEO age on the level of difficulty of different stages of capital budgeting.
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Different Stages of Capital Budgeting 345
Database and Research Methodology
All companies in India listed on BSE applying capital budgeting techniques comprise the universe of the study. A sample of 500 companies was taken covering a cross-section of various size-groups, industry- groups, age-groups, ownerships and various geographical areas. Primary data on different stages of capital budgeting were collected from the CFOs and finance directors of the sampled companies with the help of a structured questionnaire containing mainly rank order questions relating to the four well defined stages of capital budgeting, namely project definition and cash flow estimation, financial analysis and project selection, project implementation and project review.
A website was constructed to help CFOs or finance managers save their time by filling the questionnaire online. The questionnaire prepared was thus put on the website so that it can be filled online and can be directly submitted to the investigator. An attachment file of the copy of questionnaire was also sent along with a covering letter to CFO/Finance Manager/Director Finance of the sampled companies requesting them to send back the duly filled in questionnaire within a week’s time. It was also indicated to the CFOs that the individual responses would be kept strictly confidential and only aggregate generalizations would be published.
A final response of 77 CFOs of the listed Indian companies was obtained. Table 1 reveals the descriptive statistics or demographics of the respondent companies and their CFOs. The different panels of the table reveal classification of sample on the basis of different demographic characteristics.
Table 1. Descriptive Statistics of the Sampled Companies
Panel A. Classification of Sampled Companies on Basis of Size of Capital Budget
Size of Capital Budget No. of Companies % of Companies
Below `500 million 25 32.5 `500 to <1,000 million 20 26 `1,000 to <5,000 million 18 23.4 `5,000 million and above 14 18.2 Total 77 100
Panel B. Industry Wise Classification of Sampled Companies
Industry Group No. of Companies % of Companies
(1) Transport equipment/automobiles/two wheeler/motor vehicles/ tyres/auto components/automotive
11 14.3
(2) Chemicals/fertilizers/petrochemicals, paints/dyes, pharmaceutical/ biotechnology/healthcare
9 11.7
(3) Cement/iron and steelpaper/wood/glass/plastic/rubber/marbles 7 9.1 (4) Consumer durable/electronics/electrical equipments, liquor/
tobacco, FMCG 8 10.4
(5) Power/oil/gas 2 2.6 (6) Communication/telecom, IT/software development 8 10.4
(Table 1 continued)
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346 Roopali Batra and Satish Verma
Industry Group No. of Companies % of Companies
(7) Food processing/sugar 10 13 (8) Textiles/garments/cosmetics and jewellery/leather 13 16.9 (9) Services: Banking/financing/insurance, property and
construction/advertising/consultancy/hotel/travel/education/ retailing, entertainment/media
9 11.7
Total 77 100
Panel C. Company Age-Wise Classification of Sampled Companies
Age of Company No. of Companies % of Companies
<10 years 4 5.2 10 to <20 years 17 22.1 20 to <40 years 31 40.3 40 years and above 25 32.5 Total 77 100
Panel D. CEO Education-Wise Classification of Sampled Companies
CEO Education No. of Companies % of Companies
Under graduate/graduate 16 20.8 MBA 19 24.7 BE/B.TECH/M.TECH/Non MBA master 16 20.8 Other professional degree like CA, CS and CFS 13 16.9 >Master degree 13 16.9 Total 77 100
Panel E. CEO Age-Wise Classification of Sampled Companies
CEO Age No. of Companies % of Companies
<40 years 7 9.1 40 to <50 years 25 32.5 50 to <60 years 35 45.5 60 years and above 10 13.0 Total 77 100.0
Source: Primary data obtained by the author.
The data were later analyzed using cross tabulation, mean, standard deviation and percentages. Further Ks test of normality was applied to check the normality of data and it was found that the data were not normally distributed. Thus non parametric test Kruskal–Wallis H test was applied to find association between company variables and level of difficulty of different stages of capital budgeting.
(Table 1 continued)
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Different Stages of Capital Budgeting 347
Data Analysis and Results
The results and findings of the above study conducted on 77 CFOs are discussed in this section under the four heads of:
• Relative importance of different stages of capital budgeting process. • Relative difficulty in different stages of capital budgeting process. • Relative riskiness in different stages of capital budgeting process. • Company related variables affecting level of difficulty of different stages of capital budgeting.
Relative Importance of Different Stages of Capital Budgeting Process
The CFOs were asked to rank the four stages of capital budgeting from 1 to 4 on the basis of the relative importance of each stage. Tables 2, 3 and 4 show the results of the same.
Table 2. Importance of Different Stages of Capital Budgeting
Stages
Ranks
1 2 3 4 Total
Project definition and cash flow estimation 26(33.8) 23(29.9) 24(31.2) 4(5.2) 77 Financial analysis and project selection 36(46.8) 36(46.8) 3(3.9) 2(2.6) 77 Project implementation 13(16.9) 14(18.2) 40(51.9) 10(13) 77 Project review 2(2.6) 4(5.2) 10(13) 61(79.2) 77(100)
Source: Primary data obtained by the author.
Table 3. Mean Importance Rank of Stages of Capital Budgeting: Capital Budget-Wise Classification
Stages
Size of Capital Budget
Below `500 million
`500 to <1,000 million
`1,000 to <5,000 million
`5,000 million and Above Total
Mean Rank S.D.
Mean Rank S.D.
Mean Rank S.D.
Mean Rank S.D.
Mean Rank S.D.
Project definition and cash flow estimation
2.24 0.93 1.75 0.91 2.28 1.02 2.00 0.78 2.08 0.93
Financial analysis and project selection
1.32 0.48 2.00 0.86 1.56 0.51 1.71 0.73 1.62 0.69
Project implementation
2.72 0.84 2.65 0.93 2.67 1.03 2.29 0.91 2.61 0.92
Project review 3.72 0.54 3.60 0.82 3.50 0.92 4.00 0.00 3.69 0.69
Source: Primary data obtained by the author.
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Global Business Review, 15, 2 (2014): 339–362
Different Stages of Capital Budgeting 349
Table 2 reveals that financial analysis and project selection is considered the most important stage by the majority of CFOs followed by project definition and cash flow estimation. Project implementation and project review are found to be the comparatively less important stages of capital budgeting. These results are more or less consistent with the findings of Hall and Millard (2010) study of 67 South African industrial firms where project definition and cash flow estimation and financial analysis were rated as most important stages and project review least important. The studies of Brijlal and Quesada (2008) and Hall (2000) though found project definition and cash flow estimation even more important than financial analysis, but as far as ranking of project implementation and project review are concerned, they were considered least important by all studies. Thus the Indian corporate still considered financial analysis and project selection even more important than project definition and cash flow estimation.
Mean rank of the different stages also reveals that financial analysis and project selection is the most important stage followed by project definition and cash flow estimation. Companies with small size capital budget (below `500 million) and large size capital budget (>`1,000 million) show the same results applies. However, in case of medium size companies (`500 to <1,000 million), project definition and cash flow estimation overrides financial analysis and project selection in importance.
Table 4 reveals that in cement/iron/paper/rubber industry, power/oil/gas and in services industry both project definition and cash flow estimation and financial analysis and project selection have equal mean importance. In chemical/fertilizer/pharma, ICT and textiles/jewellery financial analysis and project selection has highest mean importance followed by project definition and cash flow estimation. However, in tyres/transport, food processing/sugar, consumer durable/electronics, financial analysis is followed by project implementation.
Relative Difficulty of Different Stages of Capital Budgeting Process
The CFOs were also asked to rank the four stages of capital budgeting from 1 to 4 on the basis of the relative level of difficulty of different stage. Tables 5, 6 and 7 show the results of the same.
Table 5 shows that the majority of CFOs consider financial analysis and project selection and project implementation as most difficult, followed closely by project definition and cash flow estimation. Project review is found to be comparatively less difficult. Previous studies by Hall (2000) and Brijlal and Quesada (2008) ranked project definition and cash flow estimation most difficult stage along with financial analysis. Later, Hall and Millard (2010) study of South African firms ranked project definition and cash flow estimation most difficult along with project implementation. Thus in Indian context though
Table 5. Level of Difficulty of Different Stages of Capital Budgeting
Stages
Ranks
1 2 3 4 Total
Project definition and cash flow estimation 21(27.3) 21(27.3) 28(36.4) 7(9.1) 77 Financial analysis and project selection 25(32.5) 38(49.4) 9(11.7) 5(6.5) 77 Project implementation 24(31.2) 15(19.5) 26(33.8) 12(5.6) 77 Project review 7(9.1) 3(3.9) 14(18.2) 53(68.8) 77
Source: Primary data obtained by the author.
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350 Roopali Batra and Satish Verma
found difficult by 27 per cent respondents still project definition and cash flow estimation follows financial analysis and project implementation in order of difficulty. However, considering the first and second ranks financial analysis and project selection is far beyond the others and is followed by project definition and cash flow estimation and then project implementation. Thus in India CFOs find financial analysis and selection as difficult as project implementation. They are still not at ease with the understanding and usage of DCF techniques and risk techniques and get baffled by the existence of multiple investment appraisal techniques.
Mean rank of the different stages also reveals that financial analysis and project selection is the most difficult stage followed by project definition and cash flow estimation and project implement- ation. Project review is found to be the last in order of difficulty among all. Across companies with capital budgets (<1,000 million) the results remain same. The only exception are the companies of larger capital budget (>`1,000 million) where financial analysis and project selection is the most difficult stage followed very closely by project implementation while project definition and cash flow estimation is ranked third difficult. An interesting finding is that these large companies consider financial analysis and project implementation more or less equally difficult. While for companies with capital budget (<1,000 million) financial analysis and project selection is considered far more difficult than other stages.
Table 7 reveals that financial analysis and project selection followed by project implementation are most difficult stages of capital budgeting in case of transport, chemical/pharma, food processing industries and textiles. However, in case of consumer durable, ICT, food processing, sugar financial analysis and project selection followed by project definition and cash flow estimation is most difficult. In case of cement/iron industry project definition and cash flow estimation as well as financial analysis and project selection are considered equally difficult. The only exception is the power/oil sector and services sector (finanical, banking, insurance, education, hotel, etc.), where project definition and cash flow estimation is the most difficult followed by project implementation.
Thus in all industries financial analysis and project selection is considered most difficult except power and services industry where project definition and cash flow estimation are considered most difficult.
Table 6. Mean Difficulty Rank of Stages of Capital Budgeting: Capital Budget-Wise Classification
Stages
Size of Capital Budget
Below `500 million
`500 to <1,000 million
`1,000 to <5,000 million
`5,000 million and Above Total
Mean Rank S.D.
Mean Rank S.D.
Mean Rank S.D.
Mean Rank S.D.
Mean Rank S.D.
Project definition and cash flow estimation
2.36 1.04 2.10 1.07 2.22 0.94 2.43 0.76 2.27 0.97
Financial analysis and project selection
1.96 0.89 1.85 0.75 2.00 0.84 1.86 0.95 1.92 0.84
Project implementation 2.40 1.12 2.70 1.13 2.17 1.10 1.93 0.83 2.34 1.08 Project review 3.28 1.06 3.35 0.93 3.61 0.85 3.79 0.80 3.47 0.94
Source: Primary data obtained by the author.
T a b
le 7
. M ea
n D
iff ic
ul ty
R an
k o f St
ag es
o f C
ap it al
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ge ti ng
: I nd
us tr
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St ag
es
In du
st ry
T yp
e
Tr an
s/
A ut
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/T yr
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A ut
o
C he
m /F
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Pa in
t/
Ph ar
m a/
H ea
lt h
C em
en t/
Ir
o n/
Pa
pe r/
G la
ss /
R ub
be r
C o ns
d ur
/ El
ec /L
iq uo
r/ FM
C G
Po w
er /O
il/ G
as IC
T Fo
o d
Pr o ce
s/ Su
ga r
Te xt
lie s/
Je w
el le
ry /
Le at
he r
Se rv
ic es
F in
, B
an k
an d
In s/
H o te
l/C o ns
t/ Ed
u/ R
et ai
l/ En
t To
ta l
M ea
n S.
D .
M ea
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D .
M ea
n S.
D .
M ea
n S.
D .
M ea
n S.
D .
M ea
n S.
D .
M ea
n S.
D .
M ea
n S.
D .
M ea
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D .
M ea
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D .
Pr o je
ct d
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it io
n an
d ca
sh f lo
w
es ti m
at io
n
2. 45
0. 69
2. 22
0. 97
2 1
2 0.
76 2
1. 41
2. 13
0. 64
2. 3
0. 82
2. 85
1. 21
1. 89
1. 27
2. 27
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Fi na
nc ia
l a na
ly si
s an
d pr
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ct
se le
ct io
n
1. 73
0. 65
1. 78
0. 44
2 0.
82 1.
75 0.
89 3
1. 41
1. 38
0. 52
1. 7
0. 67
2. 15
1. 07
2. 56
0. 88
1. 92
0. 84
Pr o je
ct
im pl
em en
ta ti o n
2. 36
1. 36
2. 11
1. 17
2. 29
1. 25
2. 5
1. 2
2. 5
0. 71
2. 87
0. 83
2. 1
1. 1
2. 15
1. 07
2. 44
0. 88
2. 34
1. 08
Pr o je
ct r
ev ie
w 3.
45 1.
04 3.
89 0.
33 3.
71 0.
49 3.
75 0.
46 2.
5 2.
12 3.
62 1.
06 3.
9 0.
32 2.
85 1.
07 3.
11 1.
27 3.
47 0.
94
S o
u rc
e : Pr
im ar
y da
ta o
bt ai
ne d
by t
he a
ut ho
r.
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352 Roopali Batra and Satish Verma
Table 8 reveals that older companies (with age 40 years and above) consider project implementation most difficult followed by financial analysis and project selection. However, for younger companies (with age <20 years and 20 to <40 years), financial analysis and project selection is still most difficult followed by project definition and cash flow estimation. Especially youngest companies (with age <20 years) have very high mean rank for financial analysis and project selection. This may be due to the fact that these companies have lack of experience and thus are inexperienced in usage of capital budgeting techniques.
Table 9 reveals that undergraduate/graduate, MBA, B.TECH/M.TECH/non MBA masters and even those with higher degrees (>Masters degree) CFOs consider financial analysis and project selection most difficult stage followed by either project definition and cash flow estimation or by project implementation. The only striking exception is CFOs possessing other professional degrees such as CA, CS, who find project implementation most difficult followed by project definition and cash flow estimation. Thus CFOs with professional degree consider financial analysis and project selection stage not so difficult may be because of their expertise.
Table 10 reveals that CFOs with age <50 years consider project definition and cash flow estimation and financial analysis and project selection the most difficult stages with little difference in the ranking of the two stages. However, in companies with CFOs age >50 years financial analysis and project selection is found most difficult followed by project implementation. Thus older CEOs consider financial analysis difficult while relatively younger ones find project definition and cash flow estimation equally difficult.
Relative Riskiness of Different Stages of Capital Budgeting Process
The CFOs were also asked to rank the four stages of capital budgeting from 1 to 4 on the basis of the riskiness of different stage. Tables 11, 12 and 13 show the results of the same.
Table 8. Mean Difficulty Rank of Stages of Capital Budgeting: Company Age-Wise Classification
Stages
Age of Company
<20 Years 20 to <40 Years 40 Years and
Above Total
Mean Rank S.D.
Mean Rank S.D.
Mean Rank S.D.
Mean Rank S.D.
Project definition and cash flow estimation
2.10 1.04 2.10 0.91 2.64 0.91 2.27 0.97
Financial analysis and project selection 1.67 0.66 2.06 0.93 1.96 0.84 1.92 0.84 Project implementation 2.86 0.85 2.42 1.20 1.80 0.87 2.34 1.08 Project review 3.38 1.07 3.42 0.89 3.60 0.91 3.47 0.94
Source: Primary data obtained by the author.
T a b
le 9
. M
ea n
D iff
ic ul
ty R
an k
o f St
ag es
o f C
ap it al
B ud
ge ti ng
: C FO
E du
ca ti o n-
W is
e C
la ss
ifi ca
ti o n
St ag
es
C FO
E du
ca ti o n
U nd
er G
ra du
at e/
G ra
du at
e M
B A
B E/
B .T
EC H
/M .T
EC H
/ N
o n
M B
A M
as te
r O
th er
P ro
fe ss
io na
l D
eg re
e >
M as
te r
D eg
re e
To ta
l
M ea
n R
an k
S. D
. M
ea n
R an
k S.
D .
M ea
n R
an k
S. D
. M
ea n
R an
k S.
D .
M ea
n R
an k
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ea n
R an
k S.
D .
Pr o je
ct d
ef in
it io
n an
d ca
sh f lo
w e
st im
at io
n 1.
88 0.
96 2.
58 1.
07 2.
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73 1.
92 1.
19 2.
38 0.
65 2.
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97
Fi na
nc ia
l a na
ly si
s an
d pr
o je
ct s
el ec
ti o n
1. 75
0. 77
2. 11
0. 46
2 1.
15 2.
54 0.
66 1.
15 0.
38 1.
92 0.
84
Pr o je
ct im
pl em
en ta
ti o n
2. 69
0. 95
2. 11
1. 24
2. 44
1. 21
1. 85
0. 9
2. 62
0. 87
2. 34
1. 08
Pr o je
ct r
ev ie
w 3.
69 0.
6 3.
21 1.
23 3.
06 1.
18 3.
69 0.
63 3.
85 0.
38 3.
47 0.
94
S o
u rc
e : Pr
im ar
y da
ta o
bt ai
ne d
by t
he a
ut ho
r.
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354 Roopali Batra and Satish Verma
Table 11. Riskiness of Different Stages of Capital Budgeting
Stages
Ranks
1 2 3 4 Total
Project definition and cash flow estimation 19(24.7) 13(16.9) 31(40.3) 14(18.3) 77 Financial analysis and project selection 24(31.2) 44(57.1) 7(9.1) 2(2.6) 77 Project implementation 33(42.9) 17(22.1) 24(31.2) 3(3.9) 77 Project review 2(2.6) 2(2.6) 15(19.5) 58(75.3) 77
Source: Primary data obtained by the author.
Table 12. Mean Riskiness Rank of Stages of Capital Budgeting
Stage of Capital Budgeting
Size of Capital Budget
Below `500 million
`500 to <1,000 million
`1,000 to <5,000 million
`5,000 million and Above Total
Mean Rank S.D.
Mean Rank S.D.
Mean Rank S.D.
Mean Rank S.D.
Mean Rank S.D.
Project definition and cash flow estimation
2.84 0.99 2.20 1.11 2.44 1.10 2.50 1.02 2.52 1.06
Financial analysis and project selection
1.56 0.58 2.00 0.46 1.89 0.83 2.00 0.88 1.83 0.70
Project implementation
1.92 0.91 2.05 1.15 2.06 0.87 1.79 0.89 1.96 0.95
Project review 3.68 0.48 3.75 0.55 3.61 0.85 3.64 0.84 3.68 0.66
Source: Primary data obtained by the author.
Table 10. Mean Difficulty Rank of Stages of Capital Budgeting: CFO Age-Wise Classification
Stages
Age of CFO
<40 Years 40 to <50 Years 50 to <60 Years 60 Years and
Above Total
Mean Rank S.D.
Mean Rank S.D.
Mean Rank S.D.
Mean Rank S.D.
Mean Rank S.D.
Project definition and cash flow estimation
2 0.9 1.88 1.054 2.46 0.919 2.7 0.675 2.27 0.968
Financial analysis and project selection
2 1 2.04 0.841 1.94 0.873 1.5 0.527 1.92 0.839
Project implementation 2.71 1.254 2.64 1.036 2.06 1.027 2.3 1.16 2.34 1.083 Project review 3.14 1.215 3.44 0.87 3.54 0.919 3.5 1.08 3.47 0.94
Source: Primary data obtained by the author.
T a b
le 1
3 .
M ea
n R
is ki
ne ss
R an
k o f St
ag es
o f C
ap it al
B ud
ge ti ng
: I nd
us tr
y Ty
pe -W
is e
C la
ss ifi
ca ti o n
St ag
es
In du
st ry
T yp
e
Tr an
s/ A
ut o m
/ Ty
re s/
A ut
o
C he
m /F
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Pa in
t /P
ha rm
a/ H
ea lt h
C em
en t/
Ir o n/
Pa pe
r/ G
la ss
/R ub
be r
C o ns
d ur
/ El
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iq uo
r/ FM
C G
Po w
er /
O il/
G as
IC T
Fo o d
Pr o ce
s/ Su
ga r
Te xt
lie s/
Je w
el le
ry /
Le at
he r
Se rv
ic es
-F in
, B
an k
an d
In s/
H o te
l/C o ns
t/ Ed
u/ R
et ai
l/ En
t To
ta l
M ea
n S.
D .
M ea
n S.
D .
M ea
n S.
D .
M ea
n S.
D .
M ea
n S.
D .
M ea
n S.
D .
M ea
n S.
D .
M ea
n S.
D .
M ea
n S.
D .
M ea
n S.
D .
Pr o je
ct d
ef in
it io
n an
d ca
sh f lo
w
es ti m
at io
n
3. 00
0. 89
2. 33
1. 12
2. 43
0. 98
2. 50
1. 20
2. 00
1. 41
1. 75
0. 89
3. 10
0. 74
2. 54
1. 13
2. 33
1. 22
2. 52
1. 06
Fi na
nc ia
l a na
ly si
s an
d pr
o je
ct
se le
ct io
n
1. 73
0. 47
1. 67
0. 50
2. 29
0. 49
1. 75
0. 46
3. 00
1. 41
2. 00
0. 76
1. 60
0. 70
1. 85
0. 69
1. 67
1. 00
1. 83
0. 70
Pr o je
ct
im pl
em en
ta ti o n
1. 64
0. 92
2. 11
0. 93
1. 57
1. 13
2. 00
1. 07
2. 50
0. 71
2. 00
0. 93
1. 60
0. 70
2. 08
1. 19
2. 56
0. 53
1. 96
0. 95
Pr o je
ct r
ev ie
w 3.
64 0.
67 3.
89 0.
33 3.
86 0.
38 3.
75 0.
46 2.
50 2.
12 4.
00 0.
00 3.
70 0.
48 3.
54 0.
66 3.
44 1.
01 3.
68 0.
66
S o
u rc
e : Pr
im ar
y da
ta o
bt ai
ne d
by t
he a
ut ho
r.
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356 Roopali Batra and Satish Verma
Table 11 reveals that project implementation is considered to be most risky stage by nearly 43 per cent CFOs who rank it first in riskiness followed financial analysis and project selection ranked first by 31 per cent CFOs. These results are consistent with Hall and Millard (2010) who found project implementation most risky in South African firms. However, he found project definition and cash flow estimation also of equal risk which opposes our study where financial analysis is comparable to project implementation in riskiness while project definition is ranked third. There seems to be a marked increase in the risk consideration that especially the project implementation stage carries.
However, by clubbing the first and second ranks, the results change, financial analysis and project selection is considered highly risky by nearly 88 per cent CFOs followed by project imple- mentation by 65 per cent CFOs. Project definition and cash flow estimation is clearly third in level of riskiness and project review is considered least risky by all. However, it contrasts with previous conclusions by Hall (2000), who found that the project definition and cash flow estimation were considered to be significantly more risky (46.2 per cent) than any other stage. Thus in Indian context financial analysis was considered to be still relatively more risky in spite of increase in level of education and experience of the respondents.
However, when compared on the basis of mean rank, it is clearly visible that financial analysis and project selection is considered highly risky stage with highest mean rank followed by project implementation. Project definition and cash flow estimation is undoubtedly third in level of riskiness and project review is considered least risky with CFOs giving it the last ranks. These results remain more or less same across companies with size of capital budget <`5,000 million. However, it is interesting to note that in case of companies with very high capital budget exceeding `5,000 million, CFOs feel that project implementation is much more risky than financial analysis and project selection.
In transport/tyre, cement/iron and steel and food processing, power/oil industries project imple- mentation is considered most risky stage. However, in chemicals/pharma/fertilizer, consumer durable/ electronics, food processing, textiles and services industry, financial analysis is still considered most risky.
Thus except in case of ICT industry, where project definition and cash flow estimation is the most risky stage, in all other types either financial analysis and project selection or project implementation is considered highly riskiest.
Company Related Variables Affecting Level of Difficulty of Different Stages of Capital Budgeting
To study the impact of company related variables on the level of difficulty of different stages of capital budgeting non parametric Kruskal–Wallis test of association was applied as the data were not normally distributed. Table 14 shows the results of the same.
Table 14 reveals the results of Kruskal–Wallis Test (H test) to study impact of company related variables on level of difficulty of capital budgeting stages. The test when applied to check whether there is statistically significant difference between the different sizes of capital budget as regards their level of difficulty of different capital budgeting stages reveals that there is an insignificant difference at 5 per cent level of significance. Thus size of capital budget of a company does not affect the level of difficulty of different stages of capital budget.
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Different Stages of Capital Budgeting 357
Table 14. Kruskal–Wallis Test of Association between Different Company Variables and Level of Difficulty of Capital Budgeting Stages
Company Variables
Stages of Capital Budgeting
Results
Project Definition and Cash Flow
Estimation
Financial Analysis and Project Selection
Project Implementation Project Review
Size of capital budget
Chi-square 1.30 0.48 4.66 5.92 df 3 3 3 3 Asymp. sig. 0.72 0.92 0.19 0.11
Nature of industry Chi-square 7.68 12.59 3.67 15.44 df 8 8 8 8 Asymp. sig. 0.46 0.12 0.88 0.05
Age of company Chi-square 5.74 2.34 11.32 1.73 df 2 2 2 2 Asymp. sig. 0.04 0.31 0.00 0.42
CFO education Chi-square 7.82 25.89 6.27 6.29 df 4 4 4 4 Asymp. sig. 0.09 0 0.18 0.17
CFO age Chi-square 8.28 3.12 5.18 1.79 df 3 3 3 3 Asymp. sig. 0.04 0.37 0.15 0.61
Source: Primary data obtained by the author.
Further it shows that there is statistically significant difference between the different industry types as regards their level of difficulty of project review stage of capital budgeting while for all other stages the differences are insignificant at 5 per cent level of significance. Thus nature of industry does not affect the difficulty at different stages of capital budgeting except in case of project review rankings.
Similarly company age affects difficulty level faced in project definition and cash flow estimation and project implementation stages of capital budgeting where the results are significant but not for the other stages.
Also, there is a statistically significant difference across different CFO educational classes for the level of difficulty as regards only financial analysis and project selection stage of capital budgeting. Thus CFO education affects difficulty level in this stage only.
As regards CFO’s age, it affects the level of difficulty for project definition and cash definition stage of capital budgeting and not the other stages.
Findings and Conclusion
Indian capital budgeting survey literature reveals that very few studies have been conducted on the different stages of capital budgeting. The stages of project definition/identification, project approval, project implementation, project review and issues such as cash flow estimations, post audit have been
Global Business Review, 15, 2 (2014): 339–362
358 Roopali Batra and Satish Verma
neglected by researchers and have not been given their due importance. Only a few studies conducted by Porwal (1976), Cherukuri (1996), Bedi (2000) and Singh et al. (2012) have touched some of these aspects. Further little research has been done on the relative importance and difficulty of the different stages.
As per CFOs rankings, Financial Analysis and Project Selection is considered to be the most important stage of capital budgeting followed by project definition and cash flow estimation. Project implementation and project review were found to be the comparatively less important stages of capital budgeting. However, in case of companies with medium size capital budget (`500 <1,000 million), project definition and cash flow estimation was found to be most important followed by financial analysis and project selection. The same trend was witnessed across different types of industries. However, in case of tyres/transport, food processing/sugar and consumer durable/electronics industry project implement- ation was given importance over project definition and cash flow estimation in the second position of importance.
Further survey evidence reveals that Financial Analysis and Project Selection is found most difficult by the majority of CFOs followed closely by both project implementation and project definition and cash flow estimation stage. In case of companies with larger capital budgets (>1,000 million), financial analysis and project implementation were found equally difficult. While for companies with capital budget (<1,000 million) financial analysis and project selection was considered far more difficult than all other stages. Similarly across all industries financial analysis and project selection were considered most difficult except power and services industry where project definition and cash flow estimation was ranked most difficult. Older companies considered project implementation most difficult followed by financial analysis and project selection. However, relatively younger companies still find financial analysis and project selection most difficult followed by project definition and cash flow estimation. All CFOs, even those with higher degrees (>Masters degree) considered financial analysis and project selection most difficult stage. Only exception is CFOs with other professional degrees such as CA, CS, who found project implementation most difficult stage. Older CFOs (>50 years) considered financial analysis difficult while relatively younger ones (<50 years) found project definition and cash flow estimation equally difficult. It was further observed that size of capital budget of a company does not affect the level of difficulty of different stages of capital budget. The nature of industry was also not found to affect the difficulty at different stages of capital budgeting except in case of project review rankings. However, company age was found to affect difficulty level faced in project definition and cash flow estimation and project implementation stages of capital budgeting. Apart from financial analysis and project selection stage of capital budgeting, CFO education was also not found to influence the difficulty of other stages. The CFO age was found to affect level of difficulty for project definition and cash definition stage of capital budgeting and not the other stages.
In riskiness ranking by CFOs same results were observed, Financial Analysis and Project Selection was considered most risky stage with highest mean rank followed by project implementation. Project review was considered least risky by the CFOs. These results remain more or less same across companies with size of capital budget <`5,000 million. However, it is interesting to note that in case of companies with very high capital budget exceeding `5,000 million, CFOs felt that project implementation is much more risky than financial analysis and project selection. Across different industry types, except in case of ICT industry, where project definition and cash flow estimation is the most risky stage, in all other types either financial analysis and project selection or project implementation is considered highly riskiest.
Global Business Review, 15, 2 (2014): 339–362
Different Stages of Capital Budgeting 359
Thus in Indian corporate sector, CFOs of different age groups and educational qualifications across different company ages, sizes and industries still unanimously feel that financial analysis and project selection is still the most important and even the most difficult among the different stages of capital budgeting followed by project definition and cash flow estimation. Considering the risk involved CFOs again rate financial analysis and project selection most risky but followed by project implementation. Project review appears to be the stage given not much importance and considered least risky or difficult by the majority of Indian CFOs. These findings are different from other foreign research studies conducted across the globe where project definition and cash flow estimation was found to be the most crucial stage from all aspects. However, the Indian CFOs considers this stage crucial but relatively less than financial analysis and project selection.
Insights for Future Research
Over the past two decades, the focus of several prominent capital budgeting Indian surveyors has been on the selection stage only. Thus there is a need to rebalance and redirect its capital budgeting research efforts away from merely analyzing and narrating what techniques firms used in the stage 3 (financial analysis and selection). Future researchers need to devote more resources to studying stages of identification, development, control and other specifically neglected areas in stage of selection, since these are the most unexplored areas of capital budgeting. Though some Indian researchers have made an attempt to touch these areas, firstly their number has been very few. Secondly these researchers made no effort to go in for an in-depth investigation of these neglected areas.
The selection stage, with its emphasis on particular project evaluation techniques, has always dominated the survey topics over the entire review period. As a result, there are many opportunities and insights for future research that still await surveyors to deeply delve into the capital budgeting process by re-focusing their efforts towards the neglected stages. Opportunities include emphasizing on a particular stage (e.g. the relatively unexplored identification stage), researching a phase within a stage (e.g. risk analysis within the selection stage) or contributing detail to the overall four-stage process. Many promising areas like studies focusing on project definition, cash flow estimations, project development and approval, capital rationing, performance review, post audit can be conducted. Another upcoming area of real options can be explored even further.
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