MANAGEMENT RESEARCH METHODS

CAPITAL BUDGETING: COMPARISON OF

TRADITIONAL MODELS
TABLE OF CONTENT
1. INTRODUCTION
2. LITERATURE MAP
3. RESEARCH QUESTION AND METHODOLOGY USED
4. THOROUGH CRITIQUE OF ARTICLE WHERE A KNOW RESEARCH
METHODOLOGY WAS USED.

4.1.1 HOW WAS THE RESEARCH METHOD APPLIED

4.1.2 CONTRIBUTION OF THE METHOD TO THEORY AND RESEARCH
4.1.3 GAPS WHICH MAY BE PRESENT

4.2.1. HOW WAS THE RESEARCH METHOD APPLIED

4.2.2 CONTRIBUTION OF THE METHOD TO THEORY AND RESEARCH
4.2.3 GAPS WHICH MAY BE PRESENT

5.CONCLUSION
6. REFERENCE
CAPITAL BUDGETING: COMPARISON OF TRADITIONAL MODELS

INTRODUCTION
Financial decision making for investing firms require metric apparatuses for examination,
comparison and analysis. The main aim of capital budgeting is to maintain fluent long term
plans and strategies to ensure lucrative future for a company .The managerial choice among
many investment alternatives with complex possibilities has made it easier to depend on
computer algorithms that take into account the risk factors and levels, important cash flows
and other factors .
Base of this future planning arranging is the capacity and ability to settle on choices to
supplant, enhance, and extend the company's major existing asset base, when contrasted with
just looking for the productivity of the utilization of that asset base.( VOLKMANN 1997)
developed yield-based capital budgeting method that is commensurate with shareholders
wealth maximization principle. While maintaining a business, settling on the correct choices
can prompt achievement and success while taking the wrong ones can result to failure. With
such great amount of money and risk riding on each choice, it’s critical that insightful
thought is put into every single decision that should be made. To help them, numerous
business pioneers experience an astute decision making process. While there are many
options of decision making techniques, devices, numerous have a tendency to spin around a
similar key standard of making decision for the choice that should be made, considering and
inquiring about the choices and exploring the option once it has been made (CHRISTIAN
KALHOEFER 2010) showed that problem of ranking of mutually exclusive projects using NPV
and IRR is due to insufficient application of the investment appraisal techniques. Capital
planning is a long haul making arrangements for duty of assets to settles resources. For
assessing long term arrangements managers utilize the basic techniques Payback
period(PBP), Discounted payback(DPBP), Internal rate of return(IRR), net terminal
value(NTV), Net present value(NPV), Profitability index(PI). Every one of the procedures is
critical for making investment choices .(WEBER 2014) introduced the selective IRR, a return
criterion which is NPV-consistent. Talking into consideration the discoveries of global and
national research analysis in the region of investment, the articles analysed in literature
review intends to give a thorough survey of capital planning strategies that are most often
utilized in corporate world in different fields, and also point out new research queries.
LITERATURE MAP

Figure 1 shows us the different types of methods used for studies in capital budgeting field.
(THOMAS A. WEBER 2013) states Internal rate of return is for the most part thought to be
sub-par compared to the net present value (NPV) as an instrument for assessing and
positioning undertakings, in spite of its intrinsically valuable likeness to the cost of capital
and the return of other investment openings. We present the ''Selective IRR'', an return
standard which, as a determination of a broadened set of conceivable IRRs. The selective
IRR dependably exists, is interesting, simple to process, and does not experience the ill
effects of disadvantages that come upon the project investment rate, the just other known
NPV-consistent return foundation.( BANERJEE 2016) says about the contravention between
NPV and IRR due to timing of cash flow. It is discovered that because of severity of discount
factor, timing of money streams of undertakings prompts contradicting outcomes as
delineated by Net Present Value and Internal Rate of Return.
Data and methodology used in the study of closed source and has been gathered by
interviewing the directors of some companies. To come to a decision for choosing best
alternative ranking of capital budgeting.
NPV is depicted as the contrast between present values of income( trade turning out) and
present value of outpouring money. Money inflows that are isolated by various periods are
changed over into identical present esteem.

NPV= ∑CT/ (1+K)^T – CO

CT= CASH INFLOWS VALID IN THE TIME PERIOD OF PROJECT

T = 1,2,3...NTH ( TIME PERIOD)
K= DISCOUNTING RATE OF FIRMS COST OF CAPITAL
CO= CASH OUTFLOW

IRR IS THAT RATE WHICH COMPARES THE PRESENT VALUE OF MONEY INFLOWS WITH PRESENT
ESTIMATION OF CASH OUTFLOWS. IT IMPLIES THAT AT IRR THE NPV ENDS UP ZERO.

∑CT/ (1+K)^T – CO= 0

(ASMA ARSHAD 2012) analysed that NPV is better than IRR the points author puts forward
for this comment is that, NPV depends on capital cost of a project whereas IRR is calculated
on its rate which is to be calculated. Another aspect that the author explains is that when
mutually exclusive project are taken into account NPV is a better choice and in case of an
individual project we can choose IRR. For the study 40 copy righted books from google were
selected without bias, to arrange the information ordinal scale was utilized and after that
examine the information by aggregate, mean and graphical introduction.
(VOLKMAN 1997) made an yield based capital budgeting method. In the article author has
mentioned academic survey in corporate management which mostly jolts down to the point
that corporate management prefers yield based capital budgeting method (like IRR) rather
than cash flow discount (NPV). Author further ranks NPV as least utilized within corporate
management and considers IRR most appropriate. But in the article it is also mentioned that
previous yield based method are not congruent in profiting share wealth in many economic
situations.
The gap which is to be marked in this article is that theory developed in this study mollifies
corporate administration's inclination for a yield-based measure while keeping up the
Fisherian assumption of wealth augmentation. (JONAS MACKEVICIUS, VLADISLAV
TOMASEVIC 2010) shared results of different projects with regards to scope, length and
anticipated profit by determining objectively NPV AND IRR.
Authors stated that results often correlate but they may differ in some cases. Author called it
as “conflict between the IRR and NPV methods”. Author also suggested a technique for the
resolution of this conflict.
The method used for this was general method of analysis of scientific literature, evaluation
and analysis of economic indicators. The technique developed was based on methods of
modelling enterprise processes, value and cost of capital.
(OSAMA SAMIH SHABAN, ZIAD AL-ZUBI AND AHMAD ADEL ABDALLEH 2017) , this research
was carried out to study the scope and extent of using capital budgeting tools for a suitable
project. Apart from NPV and IRR this research also focus on Pay Back Period.
The study was initiated by creating a questionnaire and the motive was to circulate the
questionnaire to maximum number of Jordanian industries irrespective of their scale. The
acquired data was processed using SSPS. The motive was to provide or find the attractiveness
of different capital budgeting tools in different scale fields. (GRAHAM AND HARVEY 2001)
have surveyed capital budgeting in large firms and small firms by taking into account 392
CFO’s. Author explained that large firms mostly depend on present value technique and asset
pricing scheme, on the other hand small firms use payback method.
Other important thing which was shown in the study was that significant number of company
use monetary risk over project risk in examining new project investment.
 Research questions, Theories and methods
AUTHOR
Osama Samih Shaban, Ziad Al-Zubi and
Ahmad Adel Abdalleh(2017)
Divya Gupta (2017)
Banerjee (2016)
Jones Stamalevi (2016)
Lingesiya Kengatharan (2016)
Paula de Souza and Rogerio Lunkes
(2016)
Thomas A. Weber (2013)
Asma Arshad (2012)
RESEARCH QUESTION
Which tool is considered most
important by decision makers
for deciding best possible
alternative of investment?
What is relation between
capital budgeting decision and
firms size in Indian
companies?
What are the causality between
cash stream and contravention
of NPV and IRR in context to
capital budgeting decisions?
What is the importance of
payback method in capital
budgeting decision in regards
to other techniques?
How capital budgeting
decisions have changed in last
two decades and how?
What are capital budgeting
tools used by large Brazilian
firms and why is one tool is
preferred over other?
Why IRR is considered inferior Regression analysis using primary
to NPV? How selective IRR
can be a replacement for IRR?
How NPV is better than IRR?
THEORY/METHODOLOGY USED
Quantitative analyses using SPSS
Finding out values for similar
investment.
Quantitative analysis.
OLS(observed least squared) model
is used to evaluate asset size and
turnover.
Quantitative analysis using
regression analysis.
Conceptual analysis using Secondary
data.
Quantitative analysis.
Quantitative analysis using Variance
analysis
data.
Quantitative analysis done using
ordinal scale.
Jonas Mackevicius, Vladislav Tomasevic How NPV and IRR allow to Conceptual analysis using Secondary
(2010) objectively determine data.
effectiveness of an investment
project?

Davina F. Jacobs (2008) How capital budgeting was Mixed analysis

working in past as compared to
present in public investment
and how practices differ from
low income countries to
developed countries?

Graham and Harvey (2001) What are the difference in Questionnaire distributed based on
approach of large firms as Likert scale.
compared to small firms in
budgeting decisions?

Volkman (1997) Why corporate managers Quantitative analyses using primary

prefer yield based models like data
IRR as compared to cash flow
models?

The table mentioned gives us 12 journal articles which were examined by different theories,
methods and models used by the authors on capital budgeting technique.
Neutral to opinion

Supports NPV

Supports IRR

CAPITAL BUDGETING TOOLS

Davina F. Jacobs (2008)

Banerjee (2016) Jones Stamalevi (2016)

Saban, Al-Zubi, Abdalleh(2017)

Thomas A. Weber (2013)

Lingesiya Kengatharan (2016)

Divya Gupta(2017)

Asma Arshad (2012)

Graham and Harvey (2001)
Jonas Mackevicius, Vladislav Tomasevic (2010)

Volkman (1997) Paula de Souza and Rogerio Lunkes (2016)

Thorough critique of articles in which a known researched
methodology was used.

Osama Samih Shaban1 , Ziad Al-Zubi1 & Ahmad Adel Abdallah(2017)

4.1.1 How was the research method applied

Among the many methodologies used in the paper Graham and Harvey survey was the most
important and significant. Primary data was collected by a survey questionnaire which was
sent among 66 companies in the Jordan industrial sector. The questionnaire was based on 5
point Likert scale and had 10 queries (0 pointed out that method was never used, 1 suggested
that it was used sometimes, 2 marked as often used, 4 that method was almost used every
time ,5 refers too always used). The sample size was diverse and included both large and
small firms, different ownership was also considered in the survey. Large and small firms
were separated in terms of number of employees working and respective sales in a particular
period. The questionnaires were given out to CFO (Chief Financial Officer) personally.

Secondary data was also collected from journals, books , dissertations.

SSPS was applied on the data received for analysing. Descriptive statistics, frequencies and
percentages were used to analyse the survey data.

Authenticity of this survey stands due to the fact that 51 out of the 66 companies replied to
the survey (77%).

4.1.2 Contribution of the method to theory and research

The major finding of this research paper was validating the fact that NPV was the most
commonly used method in the worth of projects or assets. Among the Jordanian industrial
companies analysed, majority of them claimed to have been using NPV method followed by
the Payback Period and lastly the Internal Rate of Return. One of the interesting finding that
stemmed from the research was how the size of the firm and its initial investment capacity
effected the method it used as the larger firms relied on the NPV method and did not like to
alter their ways of assessing the value of projects, but the smaller companies who did not
have a large initial investment were more open to the idea of using other ways like the
Payback Period and the Internal Rate of return (IRR). This finding supplements the findings
of Andor, Mohanty and Toth, who were in the forefront of research on this subject. The
research focused on assessing management in choosing the best capital budgeting technique
in evaluating the future investments so the paper expects managers to go with the NPV
technique mostly, followed by the Payback period and then the IRR.

4.1.3 Gaps the method may present

Although the study aims to fill the gaps that may arise while analysing the results, but the
methods applied to get those results seem to pose a few problems and gaps that will be
discussed now. Firstly, the study took place in the country of Jordan and concentrated on the
CFOs working in that region, hence, generalising the finding for every CFO in every country
can be a misconception. Future studies can collect data from CFOs working in other countries
and give the research an aspect of comprehensiveness. Secondly, the paper mentions
collecting secondary data but does not specify from where the data was collected or specify
the methods through which the data was collected, the secondary data mentioned is too vague
and is not specific.
Additionally, the questionnaire that was handed out to the CFOs contained 10 questions
based on Graham and Harvey (2001), but the study was conducted in 2017, hence there is a
long gap which could lead to the study being accused of irrelevancy. Future research can base
the questionnaire on recent surveys which pertain to the practices going on in today’s work
environment. The Sample size was also not comprehensive or large enough to support a
hypothesis of this size and can be included as a gap. Qualitative methods involving In-Depth
interviews can also be carried out with the CFOs of smaller firms in order to understand the
reasons that make them use NPV much less as compared to larger firms.

ASMA ARSHAD(2012)

4.2.1How was the research method applied

The study is conducted for testing hypothesis , and collection of data is with least integration
and unit of analysis. Secondary data is used and collected by examples of author and their
opinions. Google books are preferred for validating authors view about NPV being better
than IRR. 40 copy righted books were referred of different authors and streams.
MS excel 2007 was used for the analysis of data. It was done on the basis of authors point of
view assembled arbitrarily and then again these perspectives were broke down under various
controls which were comprising upon various book . Reviews were sorted by ordinal scale it
includes “yes” for favour, “no” for against and “c” for those who preferred both. On the basis
of views the mean was calculated and percentages were taken to analyze the data.

4.2.2 Contribution of the method to theory and research

The result of the methods used in determining whether NPV is better than IRR is done by
analysing different books and the views expressed in them are segregated to understand the
number of authors that were in favour of NPV and those in favour of IRR. The results are
divided under two categories, that are, views of randomly chosen authors and views under
different disciples.

The views of randomly chosen authors show that most of them (21) were in favour of NPV
and 4 of them were in favour of IRR and 15 authors were undecided as they claimed that in
some cases IRR is better and in some cases, using NPV is preferable and hence their view is
categorised as neutral. The bottom line being, 52.50% believed that NPV was better giving
support to the research question and validating the hypothesis, while only 10% believed that
IRR was better, solidifying the notion that IRR was less preferred and not as efficient.

The views under different disciplines is analysed by reviewing books under the discipline of
Financial Management where a scale showed that 2 books represented NPV as being better
than IRR and 1 book representing that IRR is better than NPV while the number of books
claiming that it depends on individual case is 4. In another discipline, finance, 1 book each
supported NPV,IRR and 1 book was neutral. In the third discipline, Corporate Finance, 2
books were in favour of NPV, and there was no book in favour of IRR and 2 books were
neutral. In all, hypotheses 1 was validated that said NPV is better than IRR.

4.2.3 Gaps that the paper may represent

Although IRR in its generalised way is analysed, there is another variance of IRR which has
been left neglected. The MIRR (Multiple Internal Rate of Return) which is an important
variance of IRR has not been discussed which may have led to different results or some
authors going in favour of MIRR. Other methods of evaluating the success of projects, for
example, Payback Period have been completely neglected and only two options were given to
the respondents. Additionally, a reinvestment assumption has not been taken into
consideration and also the use of yield curve or a dual equation of NPV gives two solutions
of the same equation and gives two probabilities for the same investment has not been taken
into consideration. Future researches can go into detail about the quadratic part of IRR and
the dual solution aspect of NPV can be researched. They can also provide the respondents
with further options like the Payback Period so that bias is not an option and the paper cannot
be accused of it.

CONCLUSION
After evaluating all the research papers objectively we can come to an understanding that
different firms use different capital budgeting techniques . What tool to be used depends on
the project size , risk taking power and whether or not projects are mutually exclusive.
Organisation which have high turnover and more number of employees tends to use
NPV(Net Present Value) over other methods. Companies which are small scale are inclined
towards other methods such as IRR (Internal Rate of Return) or Payback Period or sometimes
may be Profitability index. In the analysis there have been modification in IRR techniques to
make the existing one better for ex. Selective IRR has been introduced, MIRR has also been
developed.
Selection of capital budgeting technique also depends on economic status of the country.
Developed countries tend to use cash flow models(NPV) but developing nations use yield
based models instead.

To compare which model is better than the other would be difficult as under various
circumstances each model is helpful. For investing in multiple projects it’s always good to
consider cash streams and cost of capital so we NPV becomes helpful. When we have
limited resources and assets we need to see how quickly can we make profit so we use
payback method. And for single project both IRR and NPV can be used effectively.

Each of the method has its own short comings and strengths as compared to others so it is not
fit to rank techniques in general. But mostly all the authors have shown that NPV is used by
most number of organisations and IRR is the next favourite.

After reviewing the articles on capital budgeting I would like to investigate on the question
“Why do organisations don’t use selective IRR or other variations of IRR when it is yield
based model and is more beneficial than normal IRR?”

For this question I would collect primary data by interviewing or by creating a questionnaire
to know the view of financial mangers about this issue. Regrestional analysis of the data
would be done on the data received to come out with a suitable explanation for this.
Reference

1. Asma Arshad (2012) Net Present Value is better than Internal Rate of Return.
Interdisciplinary Journal Of Contemporary Research in Business 4(8). Pp 211-219

2. David A. Volkmann (1997) . A consistent yield-based capital budgeting method.

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