Capital Budgeting Practices of Twelve Large Manufacturers

Surveys of capital budgeting practices among large firms have indicated a widespread use of discounted cash flow (DCF) methods, especially internal rate of return.1 At the same time, many firms state that they also continue to use simple payback or related methods [8]. The study reported here sheds light on the differences between theory and practice in the implementation of DCF analysis. Surveys have shown that many firms use either a weighted average cost of capital or the cost of a specific source of funds in determining a hurdle rate. Most firms, however, employ some form of capital rationing that is, they restrict capital expenditures even though it generally means neglecting profitable projects.2 Under rationing, projects compete against each other, not against a profitability standard. The study reported here uses empirically determined hurdle rates and other data to examine these capital allocation practices.