The purpose of this study is to gain an insight into current capital budgeting practices in the Indian corporate sector, especially in an era where companies are increasingly exposed to various types of risks, both in the local and the global markets. A questionnaire survey was conducted on 77 Indian companies listed on the Bombay Stock Exchange in India.
The findings reveal that an uptrend towards usage of sophisticated capital budgeting techniques continues in India with use of multiple methods. The traditional payback period and the discounted cash flow (DCF) techniques of internal rate of return (IRR) and net present value (NPV) are the ones most preferred. The degree of sophistication is apparently high in larger, younger companies and those with highly qualified CEOs, even with a trend for usage of the new specialised technique of real options. Discount rate/cost of capital based on weighted average cost of capital (WACC) is the most favoured and cost of equity capital based on capital asset pricing mode (CAPM) or dividend yield model is the most popular. Sensitivity analysis technique is the most popular for consideration of risk. Linkage with corporate objectives and strategy, Customer market /demand analysis and technical considerations such as availability of raw material, power, technology, manpower and suitable project location emerge as the most important non-financial considerations in investment appraisal.
The findings of the study are in conformance with the academic theory in many respects. Indian corporate sector gives high preference to theoretically superior DCF techniques of NPV and IRR. There is an increased consideration of risk by companies with higher use of sensitivity analysis. However, theory-practice gap remains in adoption of theoretically sound techniques of real options, adjusted present value (APV), modified internal rate of return (MIRR) or simulation analysis, as these techniques are found to be adopted by only a handful of companies.
