The Contingent-Claims Approach to Investment Decisions*

This paper presents a contingent-claims approach to project valuation when capital expenditures are made sequentially over time. It focuses on an important facet of sequential investment projects that the firm can undertake—or pass up projects—as more information becomes available. The contingent-claims approach takes account of this important feature of firms' investment decision process, whereas the traditional capital budgeting procedure does not. Since the traditional method does not reflect the options nature of investment opportunities, it underestimates the value of sequential investment projects. As a result, a naive implementation of the traditional capital budgeting procedure could result in rejecting profitable projects. The extent of undervaluation associated with the traditional capital budgeting procedure is greater when the correlation between the random component of the future asset value and that of the required capital expenditure is smaller and/or when the growth rate of the required capital expenditure is higher.     

AUTOCORRELATED CASH FLOWS AND THE SELECTION OF A PORTFOLIO OF CAPITAL ASSETS *

Capital budgeting models for analyzing real assets typically are based on a set of restrictive assumptions that influence financial managers' decisions and may prevent optimization of the firm's objectives. This research examines the common restrictive assumption that cash flows are intertemporally independent by first developing an economic state and simulation model based on a Markov process for including autocorrelated cash flows in the capital budgeting decision process and then demonstrating why managers should include autocorrelated cash flows in capital budgeting models by empirically testing the impact of assuming intertemporally independent cash flows on capital budgeting decisions. The results indicate that ignoring autocorrelated cash flows seriously limits the ability of capital budgeting models to provide optimal investment decisions. The model also is very attractive for practical application because it can be implemented with a minimum number of estimates and provides the set of input data required by a number of capital budgeting models. A discussion of the implementation of the model is included.     

Investment Appraisal and Measures of Performance in Italian Divisionalised Companies

The aim of this study was to describe and analyse the current practice and trends in the development of management control practice as regards divisional investments in large Italian firms, using a survey questionnaire method. Some comparison with top North-American and German international manufacturing units were also made.The findings of the study supported two theoretical propositions. In the identification stage, firms tend to decentralise the process of capital budgeting and the control mechanism ensuring the link between corporate strategic objectives and capital expenditure projects at divisional level is based on guidelines produced by headquarters. In the selection stage firms which perceive a high interface level with the corporate strategic objectives in divisional capital expenditure tend to use discounted cash flow techniques when choosing one or more investment projects. When an economic approach is used to provide a comprehensive measure of performance, the theoretical framework fails to predict the relationship between corporate control and performance evaluation system in divisionalised companies. Essentially, financial control combines non-financial measures, used to understand manufacturing operations, with traditional accounting measures, used to understand the effects of manufacturing activities on the level of operating cash flow and operating income, as a comprehensive measures of performance in the medium-term of divisional investments.     

Corporate long-range planning groups—Some different approaches

This paper investigates several atypical roles of formal long-range planning groups and some reasons for their appearance. The study is based on three separate surveys covering 115 companies in eight industries located in both England and the United States. The authors first identify functions based on their own research and the literature which appear to make up a typical planning group role. Twenty-four of the 115 planning groups surveyed very considerable as well as sytematically from the norm. They are classified into three major categories described as (1) capital budgeting groups, (2) project development groups, and (3) think tank groups.     

资本预算的层次与相宜经济指标的应用方法

资本预算应该划分为三个层次。不同层次适用的经济评价指标及其应用方法大不相同。对资本预算不同层次间差异的清醒认识对于避免投资决策失误意义重大。     

Designing a capital budgeting system that works

Conventional capital budgeting systems do not fully reflect or adequately respond to the way in which capital expenditure decisions are actually made. Evidence also exists that the nature of this decision process is dependent on the type of the organization. This paper describes an empirically developed understanding of how capital expenditure decisions are being made, identifies ways to support and improve these decisions, and proposes an approach to linking the design of capital budgeting systems with the type of organization in which they are to operate.     

Marketing planning in India—A survey

This paper describes the response to a study of the marketing planning function in large-size companies in India and the techniques used to assess the level of sophistication achieved. The authors analyse their findings and conclude that although a high level of sophistication had not yet been achieved, the process was accelerating and there was a positive relationship between the size of the company and its profitability and the accompanying level of marketing planning sophistication.     

How planning and capital budgeting improve SME performance

This paper focuses on the use of strategic planning among small and medium sized enterprises (SMEs) in the UK manufacturing sector. It analyses the relationship between the intensity of strategic planning, business objectives, perceived performance, changes in the business environment and the use of capital budgeting techniques. Capital budgeting is of particular interest as an area of investigation, and is one which has seldom featured in previous studies of strategic planning behaviour. These issues were investigated via a survey of UK manufacturing SMEs carried out in the winter of 1996/97.

The key results suggest that SMEs incorporate a range of objectives into their strategic planning process, with profit improvement perceived to be the most important objective, followed by sales growth. SMEs engaged in detailed strategic planning are more likely to use formal capital budgeting techniques, including the net present value method, which is consistent with maximising the companys' value. Perceived profitability and success in achieving organisational objectives were positively associated with planning detail, suggesting that strategic planning is a key component improving performance. Planning detail was also associated with a significantly higher level of perceived change in the business environment.     

INVESTMENT STRATEGY FOR A SMALL GROWTH COMPANY*

The purpose of this article is to illustrate the impact of the simultaneous investment-financing decisions required by a small growth company when accepting relatively large investment projects. By such illustration, the capital budgeting rationale for using “rules of thumb” will be clarified, and correspondingly, the implicit assumptions for approximating a company's “cost of capital” will be exposed. To provide quantitative estimates of the various impacts of different capital budgeting strategies, a relatively simple simulation model was constructed. Once the implicit assumptions are exposed, the importance of a strategy combining the rules of thumb and cost of capital criteria is evident. It is believed that this combined strategy provides a practical bridge between the “art” and science of finance.     

Informational impediments to the use of capital budgeting models

The primary purpose of this study was to empirically examine whether or not informational impediments impair or alter decision making, with specific focus on capital budgeting decisions. Based on detailed interviews of senior corporate executives, it appears that management information systems (MIS) are less than adequate in providing the information items required to utilize the non-naive methods of capital budgeting. It is therefore suggested that the MIS concept be vastly broadened in regard to such decisions.     

Koordination durch heuristische Budgetierungsverfahren

If in companies decisions are decentralised coordination problems arise. Controlling offers different instruments for coordination. Among these, budgeting is very popular. In a centralized model it is shown how capacity allocation as well as transfer pricing coordinate under the constraints of budgeting. These two principles are combined with the process of budgeting in form of a top down, bottom up or counter current planning. From the resulting nine possible combinations only five are of practical relevance. These five cases are heuristics to the coordination problem, they are analysed by extensive example calculations. It is shown that transfer pricing coordinates better than capacity allocation and counter current planning is the dominant process of budgeting. The best results are obtained with transfer pricing closing with capacity allocation.     

INVENTORY MANAGEMENT AND CAPITAL BUDGETING: A PEDAGOGICAL NOTE

This paper shows, through an alternative development of the lot size model, how the methods of capital budgeting can be logically applied to the determination of optimal inventory levels. There is no reason why inventory management needs be treated any differently than the management of fixed assets. The rule that the stock of fixed assets should be expanded until the marginal rate of return equals the marginal cost of capital results from maximizing the present value of profits as a function of the investment level. In a like manner, the “square root” formula from inventory theory results from maximizing the present value of profits as a function of the investment in inventory. In addition, formulating the inventory problem as a capital budgeting problem has advantages for incorporating deterioration, obsolescence, and other costs into the model in a more logical and less intuitive way.     

Modeling IS Planning Benefits Using ACE

This paper addresses the dearth of research on the determinants of IS planning benefits. Data were collected using a questionnaire survey of top IS executives from 450 companies in Singapore. Of the 103 responses (representing a response rate of 23%), 65 companies undertook IS planning. To test the hypothesis that the determinant-benefit relationships are likely to be nonlinear, the Alternating Conditional Expectations (ACE) algorithm was used. This appears to be the first use of ACE in IS planning research. IS sophistication, communications culture, technology forecasting, top management support, and firm size were found to be nonlinearly related to IS planning benefits (e.g., improved competitiveness, operations, and resource management). For example, IS sophistication affects improved competitiveness positively, and improved resource management negatively. It seems that IS sophistication is directed more at improving competitiveness, even though this may result in less efficient resource management due to bureaucratic procedures. However, at higher levels of IS sophistication, competitiveness stagnates and may even decrease, possibly due to bureaucratic bottlenecks. Implications of our results are discussed.     

Capital budgeting and lagrangian relaxation: A case study

This paper presents a new approach to the classical multiyear capital budgeting problem. Three basic operational principles, arising out of an actual implementation of such a model, are specifically addressed in this approach. These principles are: (1) all budgets except that of the first year possess a degree of flexibility; (2) the user favours a series of near optimal solutions to a single optimal solution; and (3) an effective low cost procedure for dealing with large problems is required. Using the particular example of capital budgeting in the area of highway maintenance, an algorithm is developed and computational results for a variety of problem sizes are presented.     

Investing in CAD: a case of ad hoc decision-making

There is growing evidence to suggest that the success of new technology is linked to whether it is introduced as part of an overall corporate strategy or alternatively as an ‘ad hoc’ response to falling profits, extended lead-times and reduced productivity. Interviewing engineering managers in leading electronics and engineering companies including BICC, Ferranti, Rolls Royce, British Aerospace, Thorn EMI and others, the author found that investment in computer-aided design was not always implemented in line with corporate strategy, but instead as part of a sub-strategy, the success of which was usually constrained by the accounting methods used to justify it as well as the attitudes adopted by senior managers. In discussing these issues, the article compares British and Japanese managements' approach to new technology and questions the validity of traditional capital budgeting methods.     

The role of the controller in strategic capital investment projects: bridging the gap of multiple topoi

Journal of Management and Governance - The literature on capital budgeting and investment proposals is rich with techniques, such as portfolio management and stage-gate project management, which...     

Codes of ethics and firm size: A stakeholder approach to strategic planning

A firm's capital budgeting and strategic planning decisions have the potential to affect many groups of people called stakeholders. A stakeholder is any group or individual who can affect or is affected by the achievement of the firm's objectives. This study examines whether the presence of a code of ethics that specifically addresses capital budgeting/strategic planning decisions will significantly raise the awareness of social responsibility during the long-run planning process. This study also examines whether firm size is associated with the awareness of social responsibility during the long-run planning process. Support was found that a code of ethics that addresses long-range planning is associated with higher awareness during the planning process. Firm size was not found to be statistically different.     

Classifying capital projects for top management decision-making

This paper is an attempt to redress a perceived imbalance in the research and literature of capital project analysis. There is a plethora of work on the quantitative aspects of project analysis, yet empirical surveys show limited use of such techniques. There is limited work on the organizational processes of project selection, but there appears to be little or no work taking place on formal organizational systems for project selection.The more quantitative literature generally takes a deductive approach using a model developed from microeconomics based on the assumption that the objective of the firm is the maximization of owners' wealth. In this paper it is argued that there is a need to take an inductive approach and place the capital investment decision in its organizational setting. This paper looks at the formal capital budgeting system within the corporate setting.It is suggested that the specific capital investment decision takes place against the background of a set of policies and constraints, which are more or less explicit.The selection of corporate projects is a complex issue, but to provide some structure so that the problems can be processed by the organization, a capital budgeting system is designed. Part of this system is the classification of projects according to some criteria. It would therefore appear that the purpose of this classification system is to aid capital project selection within an organizational context.A consideration of classification systems for capital projects is undertaken, this is followed by a survey of the classification systems which have been proposed in the capital investment literature. Finally a classification system based upon specific criteria is proposed.     

The cut-off rate for investment decisions in growth companies

In this article the author attempts to define cut-off rate for capital budgeting decisions of a “growth company” and to relate it to the firms long range planning. Dr Chandra argues that conventional measurement of cost of capital cannot be used in the growth company. In brief, he defines the cut-off rate in this type of company as— dividend yield plus the rate at which dividend is expected to grow.     

基于企业生命周期的智力资本对企业价值影响研究

以我国高科技上市公司为样本的分组回归结果表明,高科技企业的智力资本不但显著影响企业价值创造结果,而且显著影响资本市场对企业市场价值的感知与评价;企业生命周期在智力资本与企业价值之间确实具有调节效应,智力资本要素在不同企业生命周期阶段发挥的价值作用不同,处于成熟期的高科技企业智力资本发挥的价值作用最大。在企业成长期,人力资本、创新资本都是高科技企业价值创造的主要要素,显著提升企业价值;在衰退期,只有人力资本是主要提升企业价值的要素。由此,企业管理者应根据企业生命周期具体阶段制定恰当的智力资本投资和管理策略,以在复杂而激烈的竞争环境中保持企业竞争优势。