Capital Budgeting – Decision Making Practices in Pakistan

H. Jamal Zubairi

Abstract


A variety of investment analysis/ capital budgeting techniques are discussed as an essential component of standard and popularly used text books on Financial Management and Corporate Finance. Each technique has some advantages and shortcomings which a user must be aware of besides knowing which technique would be the correct tool to use for taking a decision in a particular situation.

This research paper looks into practices of firms in Pakistan companies with regard to Capital Budgeting decision making i.e. the various techniques used as well as related issues like how a firm estimates its relevant cost of capital / project risk. The paper also investigates the relationship between the various capital budgeting techniques employed and various factors such as; size of investment outlay, nature of industry, company size, growth rate and capital structure. Also probed is the extent of delegation of decision making authority in respect of capital budgeting decisions. Further, the respondents’ views on relative popularity/significance of the techniques and reasons for the same have also been studied. Furthermore, the differences in techniques and decision making practices of local and foreign companies operating in Pakistan have also been looked into.

The information/data for the above stated purpose was collected through a questionnaire from sample companies listed on the Karachi Stock Exchange (KSE). The main findings extracted from the responses to the questionnaire are, that key decision makers in Pakistani firms are quite aware of and practically using sophisticated capital budgeting techniques. The study shows that bigger size companies give greater preference to Internal Rate of Return (IRR), while smaller firms rely more on Net Present Value (NPV). Also smaller firms are keener in estimating the Pay Back Period (PP) as compared to larger companies. It is also seen that the firms relying more on debt financing or with high growth rates give more preference to the NPV technique, while low leverage and low growth firms rely more on IRR.


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