Capital budgeting practices: evidence from Sri Lanka

Abstract

Purpose – The purpose of this paper is to investigate prevailing capital budgeting practices in Sri Lankan listed companies. Design/methodology/approach – A comprehensive primary survey was conducted of 32 out of 46 chief financial officers (CFOs) of manufacturing and trading companies listed on the Colombo Stock Exchange in Sri Lanka. Garnered data were then analyzed using appropriate statistical techniques. Findings – The results revealed that net present value (NPV) was the most preferred capital budgeting method, followed closely by payback (PB) and internal rate of return (IRR). Similarly, sensitivity analysis was regarded as the dominant capital budgeting tool for incorporating risk and the widely used method for calculating cost of capital was the weighted average cost of capital. Moreover, results revealed that size of the capital budget affects the use of the capital budgeting methods (NPV, IRR and PB) and incorporating risk tool (sensitivity analysis and simulation). Further, results revealed that CFOs had higher educational qualification were preferred to use sophisticated capital budgeting practices dominantly NPV, IRR and incorporating risk tool of sensitivity analysis although they were found to be reluctant in use of accounting rate of return. In a similar vein CFOs with higher experience were preferred using IRR and sensitivity analysis. Originality/value – This study contributed to academics, practitioners, policy makers and stakeholders of the company. Moreover, this research has proffered a more reliable and comprehensive analysis of capital budgeting practices in Sri Lankan listed manufacturing and trading firms. Since Sri Lanka is an unexplored country on capital budgeting practices, this research was originally contributed to the extant literature per se.

Capital budgeting: a systematic review of the literature

“…By reading 7 papers that analyse the respondents, the profile of the financial manager may be observed. The person is usually over 30 years old, an accountant, has an MBA or post-graduate degree and has occupied their current position for over five years (for example, Leon et al, 2008;Hall & Millard, 2011;Nurullah & Kengatharan, 2015).…”

Capital Investment Appraisal Practices in the Emerging Market Economy of Sri Lanka

“…Following the techniques, the second area of capital budgeting looks at the relationship between the use of capital budgeting techniques and firm attributes. Nishat and Haq (2009), for instance, related capital budgeting techniques with firm size. They were able to establish that small firms in Pakistan tended to use PB as their preferred method while large firms mainly used the single factor Capital Asset Pricing Model (CAPM) to ascertain the cost of capital.…”

“…The review of these literature (Al-Muthairi et al, 2018;Gupta & Batra, 2016;Daunfeldt & Hartwig, 2014;Nishat & Haq, 2009;Brounen et al, 2004) disclosed that various capital budgeting methods are adopted by various firms from various countries. In this regard, the capital budgeting techniques that were practised could be placed into three different categories, namely: naive, advanced and sophisticated.…”

“…Although these studies (Pathirawasam, 2016;Nurullah & Kengatharan, 2015;Koralalage & Mudiyaselage, 2014) focused on capital budgeting practices in Sri Lanka, their findings have been asymmetrical because they had focused on a particular sector only. In comparison, the current study aims to address the gap in literature by using a larger number of listed companies from multiple sectors listed on the Colombo Stock Exchange.…”

“…In the literature (Koralalage & Mudiyaselage, 2014;Nurullah & Kengatharan, 2015;Pathirawasam, 2016) of capital budgeting practices, very few studies have looked at the terrain of capital budgeting over the last four decades within the country setting. While existing studies have provided some insights into the capital budgeting practices of Sri Lanka, these have been limited in scope, focusing mainly on the purpose of investment for capital budgeting, methods employed and their antecedent factors.…”