The current issue and full text archive of this journal is available at www.emeraldinsight.com/1056-9219.

htm

Capital budgeting practices in the Jordanian industrial corporations

Basheer Ahmad Khamees
Department of Accounting, Faculty of Business, The University of Jordan, Amman, Jordan

Capital budgeting practices 49

Nedal Al-Fayoumi
Department of Finance, Faculty of Business, The University of Jordan, Amman, Jordan, and

Ali A. Al-Thuneibat
Department of Accounting, Faculty of Business, The University of Jordan, Amman, Jordan
Abstract
Purpose The purpose of this paper is to provide additional empirical evidence about capital budgeting practices in an emerging economy. Design/methodology/approach The study utilizes a questionnaire and interview to collect data from respondents. Findings The results show that the JIC give almost equal importance to the discounted and undiscounted cash ow methods in evaluating capital investment projects. It appeared also that the most frequent used technique is the protability index followed by the payback period. Practical implications Based on these results, the researchers recommend putting a great attention to apply the concepts and techniques of capital budgeting in an appropriate manner. The corporations should also consider importance of information technology and its applications in capital budgeting. Originality/value This is the rst study applied on the capital budgeting practices and its related issues in the JIC. Keywords Capital budgeting, Jordan, Cost of capital, Ination, Communication technologies Paper type Research paper

Introduction Jordan is a country that stands at the crossing point of Europe, Asia and Africa. Its economy characterized by many traits such as; liberalization, private sector management, and highly qualied and competitive human resources (Amman Stock Exchange, 2004). In addition, Jordan has several natural resources such as phosphate and potash, and has several tourism sights. However, globalisation and the evolution of communication and information put Jordanian corporations under the pressure of increased competition. The increased competition requires that Jordanian corporations rationalise their decisions in order to reduce cost and improve the quality of their products. Rationalisation enhances the demand over relevant information for decision making, therefore the role of managerial accounting must be emphasized particularly on capital budgeting.

International Journal of Commerce and Management Vol. 20 No. 1, 2010 pp. 49-63 q Emerald Group Publishing Limited 1056-9219 DOI 10.1108/10569211011025952

IJCOMA 20,1

50

Capital budgeting (expenditures) is the process of using funds to acquire operational assets that helps the rm to earn future revenues or to reduce future costs. It is an important factor that contributes to the protability of the rm, and in turn, it is an important part of a comprehensive prot plan. Capital expenditures can be classied in some different ways. For example, they are divided into major capital additions projects and minor capital expenditures, or they can be divided into long- and short-term capital expenditures budgets (Welsch et al., 1988). In addition, they are divided into replacement and minor improvements, expansion, and strategic moves (Hilton et al., 2000). Ideas for capital expenditures usually come from several sources, such as the people who use the assets, the marketing people, top management, visionary corporate leaders, brainstorming groups and from the marketplace (Hilton et al., 2000). Capital budgeting is a familiar subject for academicians and students in business schools since it is a double face subject. It is a major area of both managerial accounting and nancial management. Prior studies, concerning capital budgeting, reveal the preferences of the nancial managers in the well-developed economies. Meanwhile, studies related to this knowledge in some emerging economies are limited. The lack of evidence about capital budgeting practices hides the extent to which practitioners utilize their presumed knowledge in the subject or it may hide some misapplications of these practices. Therefore, this study investigates the methods used by the JIC in the process of long-term investment decisions. In addition, it aims to examine the denition and estimation of the cost of capital and the utilisation of risk analysis in the methods used. The study consists of ve sections including an introduction and a conclusion. Second section reviews the previous capital budgeting literature. Third section presents the methodology and data. Finally, fourth section reports the results. Previous studies Capital budgeting practices have been extensively surveyed in many countries around the world. These surveys have focused on the main topics in the area. These topics include quantitative investment evaluation techniques, risk assessment, ination and cost of capital. Concerning the evaluation techniques, previous studies show that there is an increased use of discounted cash ow techniques in many countries. For example, Hogaboam and Shook (2004) investigated the capital investment techniques used by publicly owned forest products rms in the USA in 2001. Their results show that companies prefer the use of discounted cash ow techniques, such as the net present value method. They also found that some larger companies use more sophisticated evaluation methods, such as economic value analysis. Ryan and Ryan (2002) re-examined the capital budgeting decision methods used by the Fortune 1000 companies. They reported that net present value is the most used method followed by internal rate of return. Payne et al. (1999) compared between capital budgeting and risk assessment techniques in the USA and Canada. Their results show that there are some similarities between the two countries in the area of capital budgeting practices, for example, they found that discounted cash ow methods are used in both countries to evaluate investment decision. Kester et al. (1999) conducted surveys in six countries in the Asia-Pacic region to investigate their companies capital budgeting practices.

These countries are Australia, Hong Kong, Indonesia, Malaysia, the Philippines and Singapore. They found that companies in the countries of Asia-Pacic region give more importance to the discounted cash ow techniques than they do with non-discounted cash ow techniques. In some other countries, the situation is different. For example, Lazaridis (2004) conducted a survey on 56 Cyprian rms. The ndings of his study indicate that most of small- and medium-size enterprises in Cyprus prefer the use of the simplied evaluation techniques such as the payback period and the return on investment methods. In addition, most of these rms do not implement risk analysis in the investment decision making. Lazaridis suggests that the unfamiliarity with the scientic methods may be the reason for such results. Kester and Tsui (1998) investigated the practices of capital budgeting in Singapore. Their results show that companies in Singapore give equal importance to both internal rate of return and payback period in evaluating capital investment projects. Previous studies also show that different sectors of organizations in the same country use different sets of practices. For example, Chan (2004) examined the capital budgeting practices of Canadian municipal governments. Chan found that the majority of municipal governments do not use capital budgeting techniques. Among those who use some techniques, Chan found that most of them use the payback period technique. Referring to the cost of capital, the evidence concerning this issue is controversial. In the USA, Canada and Australia, for example, the weighted average cost of capital is the dominant method used for discount rate determination. In this context, Ryan and Ryan reveal that the weighted average cost of capital is the best starting point to determine the appropriate discount rate. They found that 83.2 per cent of the respondents chose this method. Payne et al. found that 64.4 and 46.2 per cent of the companies in the USA and Canada, respectively, use the weighted average cost of capital. Hogaboam and Shook found that this method is used by 60 per cent of the respondents in the publicly owned forest products rms in the USA. Meanwhile, in the Asia-Pacic region, Kester et al. found that only 23.8, 28.6, 29.4 and 16.1 per cent of the companies in Hong Kong, Indonesia, Malaysia and Philippines, respectively, use the weighted average cost of capital. On the other hand, they found that 57.1, 42.8, 47.1 and 32.3 per cent, of the above companies based their capital investment decisions on the cost of the specic capital used to nance the investment. They also found that 48.2 per cent of the companies in Australia use weighted average cost of capital. The results of Kester and Tsui reveal that only 10.8 per cent of the companies in Singapore use the weighted average cost, and 51.4 per cent of the companies utilise the cost of the specic capital used to evaluate their capital investments. Finally, Lazaridis found that more than half of the companies in Cyprus use the cost of borrowing and their past experience to determine their cost of capital. In order to investigate the application of the discounted cash ow techniques in the UK manufacturing companies, Drury and Tayles conducted two studies in 1996 and 1997. They found that discount rates are overstated, cash ow forecasts tend to be conservative, and ination is treated incorrectly. Finally, Drury and Tayles (1996, 1997) examined the impact of company size in UK manufacturing companies. They found no signicant difference exists between the largest and the smallest ones. On the other hand, to examine the relationship between capital budgeting sophistication and business performance, Farragher et al. (2001) conducted a study using a sample

Capital budgeting practices 51

IJCOMA 20,1

52

of 117 US corporations. Their results reveal that rm performance is not related to the use of sophisticated capital budgeting processes. In addition to the previous results concerning the capital budgeting process, the evidence pertaining to risk assessment in practice shows that sensitivity analysis and scenario analysis are conducted by companies in many countries. For example, Kester et al.; Kester and Tsui; and Ryan and Ryan reveal that companies prefer to use scenario and sensitivity analysis in risk assessment. However, there is a little real evidence support the notion that sophisticated techniques are used to analyse risk. In this context, Hogaboam and Shook found that companies rarely use the capital assets pricing model (CAPM) or other sophisticated techniques to adjust for risk. Instead, companies tend to raise their required rate of return, shorten their payback period or subjectively adjust cash ows. Choosing between total risk or portfolio approach, Hogaboam and Shook found that companies tend to use total risk approach rather than portfolio approach. For example, Drury et al. found that managers focus on a projects total risk rather than a portfolio approach, which recognizes that total risk is lower because unsystematic risk can be eliminated by diversication. Finally, Chan emphasized that the decision-making process depends on quantitative and qualitative factors. Qualitative factors include strategic planning, social responsibility, employee morale, employee responsibility, corporate image and market share. Quantitative factors, which are the typical data used in decision making, include prot or cost gures. However, both quantitative and qualitative types of factors are important if a good decision is to be made. In addition, both of them need that managers should own skill, experience, judgment and ethical standards. In practice, it seems that managers concentrate on the quantitative measures. This study is different from the previous literature in that it aims to ll the gap by providing additional evidence regard the capital budgeting practices in an emerging economy, namely Jordan. To the best of our knowledge, this is the rst study that examines how the Jordanian managers apply the capital budgeting with the context of their business environment. Research methodology In this study, we use a questionnaire and interview tools to collect data from respondents. The questionnaire aims to introduce the study objectives. It consists of 28 numbered questions. Most of them were closed type. The questionnaire consists of two parts. The rst part includes the demographical information, while the second part includes the capital budgeting techniques, cost of equity capital, ination, risk analysis, factors used in taking decisions and other aspects of the capital budgeting investments. To be sure that the respondents understand all of components of the questionnaire, we choose the interview technique. This technique will give the authors the opportunity to clarify any issues related to the included questions. In addition, the interview may enable the authors to encourage the respondents to provide the required information by reminding them that their answers are very important for the completion of the study. Therefore, the authors will be condent that the information collected from the respondents is more reliable. We distribute the questionnaire to the 81 industrial corporations in Jordan through the period from February to June 2006. The returned qualied questionnaires were 53 with a response rate of 65.4 per cent.

Description of the corporations surveyed Jordanian corporations started their business at the beginning of the 1930s of the twentieth century. At that time, three corporations were formed, and since that time the number of corporations has been increasing. According to the records of the Jordan Securities Commission, in 2005 there are 197 listed corporations on Amman Stock Exchange. These corporations are classied into four sectors, including banking, insurance, services and industry. The number of corporations in each sector is 16, 25, 75, 81, respectively. The stocks of these corporations are publicly traded in the Amman Stock Exchange through the rst and the second markets. These markets are parts of the secondary market through which trading takes place in securities that are governed by special listing requirements, in accordance with the directives for listing securities on Amman Stock Exchange (Jordan Securities Commission, 2002). We apply the survey on the industrial sector in January 2006. This sector is considered one of the most important sectors in Jordan. It consists of mining and quarrying, manufacturing, and electricity sub-sectors. The real activity in the industrial sector is around 20 per cent of real gross domestic product. In 2003, the Jordanian gross domestic product equals JD7,056 million or US$9,952 million (Central Bank of Jordan, 2004). Results Table I provides the characteristics of the respondents. The results reveal that the respondents are eligible to answer the questionnaire of the current study. It appears from the table that 60.4 per cent of them are chief nancial ofcers with accounting being the area of current qualication for 83 per cent of them. In addition, 79.2 per cent have a bachelor degree and 13.2 per cent have a masters degree. The age of 78.5 per cent of them is above 30 years. Finally, 73.1 per cent have professional experience of at least ten years. General information about capital budgeting Table II reveals the average size of the capital budget of the surveyed corporations. It can be observed from the table that the size of the annual capital budget almost falls within a small range. There are 23 corporations or 79.3 per cent of the sample indicates that their budget size is less than $30 million. The response to this question indicates that the spread of the various different budget size corporations is narrow. It appears from Table III that the main source of ideas of capital expenditures is management. This represents 81.1 per cent of the companies. When the corporations were asked if they place a limit on the size of their budgets, 26 out of 52 or 50 per cent of the companies answered the question stated that they do. When they asked about the reason, 13 or 50 per cent of the 26 corporations indicated that the limit is placed by the internal management. The results also reveal that 37 corporations or 71.2 per cent of the respondents do not seek help from external parties to analyse their capital budgeting decisions. All these results indicate that the planning for capital expenditures depends to a large extent on management itself. Capital budgeting methods Concerning the capital budgeting methods applied by the sampled companies, the respondents stated that they use all of ve well-known capital budgeting methods.

Capital budgeting practices 53

IJCOMA 20,1
Professional position Chief executive ofcer Chief nancial ofcer Chief administrative ofcer Other Total Current qualication High school or less Two or three year college Bachelor degree Master degree PhD Total Area of current qualication Accounting Finance Business administration Other Total Age , 20 years 21-30 years 31-40 years 41-50 years . 50 years Total Professional experience , 4 years 5-9 years 10-14 years 15-19 years . 20 Total

Number 1 32 1 19 53 1 3 42 7 0 53 44 1 5 3 53 3 8 19 13 8 51 5 9 12 13 13 52

Percentage 1.9 60.4 1.9 35.8 100 1.9 5.7 79.2 13.2 0 100 83 1.9 9.4 5.7 100 5.9 15.7 37.3 25.5 15.7 100 9.6 17.3 23.1 25 25 100

54

Table I. The characteristics of the respondents

These methods are net present value, internal rate of return, accounting rate of return, payback period and protability index. The results indicate that 35 corporations or 66 per cent use at least one of these methods to evaluate their capital expenditures. The remaining corporations do not use any evaluation method for the following reasons: the corporation is not familiar with these methods (26.7 per cent), the corporation does not believe that such methods could change its prot substantially (20 per cent), and the
Size of capital budget Less than $15 million $15-29.9 million $30-89.9 million Greater than 180 million Total Number 16 7 4 2 29 Percentage 55.2 24.1 13.8 6.9 100

Table II. The size of the annual capital budget

company does not have the staff, time and experience for evaluating investment projects (40 per cent). However, the remaining corporations did not specify (13.3 per cent). The results also indicate that the JIC do not rely on one method. In total of 27 corporations, or 77.1 per cent of the corporations which use methods to evaluate capital expenditures, indicated that they use more than one method in their evaluation. Moreover, the respondents were asked to determine how frequently they use the ve capital budgeting methods mentioned above. The answers were based on a ve-point Likert scale: always, often, sometimes, rarely and never. Table VIII shows the number and the percentage of the corporations use each capital budgeting technique in each alternative on the scale. To quantify the responses, the following percentages were attached to each alternative: always (100 per cent), often (approximately 75 per cent), sometimes (approximately 50 per cent), rarely (approximately 25 per cent) and never (0 per cent). Then a score for each capital budgeting technique is calculated as follows: X P N Score 35 where: P = the alternative percentage. N = the number of the corporations use the technique. 35 = the number of corporations who use at least one evaluation technique. The scores are presented in Table IV. It can be observed from the scores that differences between techniques are not minor. The results do not show that discounted or undiscounted cash ow methods are preferred over each other. However, the protability index technique has achieved the highest score.

Capital budgeting practices 55

Source The people who use the assets Marketing people Top management Visionary corporate leaders The marketplace Brainstorming groups Other

Percentage of the companies 22.6 5.7 81.1 18.9 18.9 0 1.9

Table III. Sources of ideas for capital expenditures

Technique NPV IRR ARR PP PI

Always n p (%) 13 10 5 12 13 37.1 28.6 14.3 34.3 37.1

Often n p (%) 4 9 14 7 10 11.4 25.7 40 20 28.6

Some times n p (%) 1 5 4 6 2 2.9 14.3 11.4 17.1 5.7

n 3 1 1 1 0

Rarely p (%) 8.6 2.9 2.9 2.9 0

n 14 10 11 9 10

Never p (%) 40 28.6 31.4 25.7 28.6

Score (%) 49.3 55.7 50.7 58.6 61.4 Table IV. The frequencies of using capital budgeting techniques

IJCOMA 20,1

56

The application of capital budgeting techniques The previous results show that approximately two-thirds of the industrial corporations in Jordan use at least one technique to evaluate their capital budgeting decisions. The results also indicate that protability index technique has the highest score among the different techniques. However, it is unclear until now whether these corporations use these techniques in the right way. Therefore, this section aims to investigate the misapplication of these techniques if exists. It shows how the cost of capital is determined, whether any risk analysis is implemented, and whether ination is treated properly. The cost of capital Concerning the determination of the cost of capital, 75.5 per cent of the respondent corporations stated that they use a formal approach to determine their costs of capital. The most used denition of the cost of capital is the cost of equity capital, where 48.6 per cent of the corporations surveyed use this denition. The second denition is the cost of borrowing. About 29.7 per cent of the corporations use this denition. There is only 13.5 per cent of the corporations which use their experience to determine the cost of capital. The average cost of capital is used by only 2.7 per cent, and the risk-free rate plus a premium is used by 5.4 per cent of the corporations. These results contradict the academic point of view that considers the weighted average cost of fund as the superior base level for cost of capital determination. Since this method takes into consideration the weight of each source of fund in the capital structure of the rm. Even though, the weighted average cost method assumes that the new project will have no appreciable impact on gearing. The two main reasons that explain why a corporation does not use a formal approach to determine its cost of capital are: the unfamiliarity of the company with these approaches (36.4 per cent), and the lack in staff, time, and experience for formally determining the cost of capital (36.4). There were only 9.1 per cent of the corporations who believe that such approaches could not change their prot substantially. The other 18.2 per cent of the corporations have different minor reasons for not using these approaches. Treatment of ination Ination is an important factor that affects the capital budgeting decision. In discounted cash ow analysis for example, ination affects both the cash ows and the discount rate. Therefore, decision makers should be aware of the ination effect if they desire to come upon the appropriate decision. In addition, they should use different indicators of the rate of ination because selling prices, wage rates, materials costs and overheads usually change at different rates each year. In this section, we show how the JIC deal with ination issue. The percentage changes in consumer price index in Jordan during the years 2001, 2002, 2003, 2004 and 2005 were 1.8, 1.8, 1.6, 3.4 and 3.5, respectively, (Central Bank of Jordan, 2006). When ination exists, cash ows and discount rates can be expressed in nominal or real terms. Nominal cash ows are the actual dollars to be received or paid out. Real discount rate is calculated as follows: (Ross et al., 2002):   1 nominal rate 21 Real discount rate 1 inflation rate

It should be emphasized that the two approaches give the same results, given that both cash ows and the discount rate are expressed in the same terms. To work out the above argument, assume that a machine which costs $50,000 is projected to produce the following cash ows, expressed in current prices, during the next ve years: $14,400, 18,500, 12,500, 9,400 and 6,500, respectively. The rate of ination is expected to be 4 per cent and the corporations cost of capital is 12 per cent. In this example, to treat ination properly, a decision maker should follow one of two approaches. First, the decision maker can discount the cash ows in current prices using the adjusted discount rate, which is 1 12 percent=1 4 percent2 1 7:6923077 percent. Second, the decision maker can adjust the cash ows in current prices by the ination rate, then he or she can discount the adjusted cash ows by the nominal rate 12 per cent. Table V displays the approach that discounts cash ows by the adjusted rate; meanwhile, Table VI displays the approach that discounts the adjusted cash ows by the nominal rate. Under the two approaches, the net present value is $807.09. The misapplication of ination would result in an understated or overstated net present value. For example, discounting the cash ows, in current prices, by the nominal rate will result in a negative net present value as can be seen in Table VII, which means rejecting the project. To examine how frequently ination is used by the JIC, the results of the study show that 28 corporations out of 53 or 52.8 per cent consider ination in project evaluations. The two main reasons for not considering ination are the unfamiliarity with it (38.5 per cent) and the lack in staff, time, and experience for treating ination (38.5 per cent). Another reason is the unavailability of ofcial ination data (15.4 per cent). There are only 7.7 per cent of the corporations do not believe that ination could change the results of the capital budgeting decisions.
Year 0 1 2 3 4 5 Cash ows current prices ($) 50,000 14,400 18,500 12,500 9,400 6,500 Discount factor@ 7.6923077% 1 0.928571429 0.862244898 0.800655977 0.743465627 0.690361531 Present value ($) 50,000 13,371.43 15,951.53 10,008.2 6,988.577 4,487.35 807.0857

Capital budgeting practices 57

Table V. The real terms approach

Year 0 1 2 3 4 5

Cash ow current prices ($) 50,000 14,400 18,500 12,500 9,400 6,500

Ination factor@ 4% 1 1.04 1.0816 1.124864 1.16985856 1.216652902

Adjusted cash ows ($) 50,000 14,976 20,009.6 14,060.8 10,996.67046 7,908.243866

Discount factor@ 12% 1 0.892857143 0.797193878 0.711780248 0.635518078 0.567426856

Present value ($) 50,000 13,371.43 15,951.53 10,008.2 6,988.583 4,487.35 807.0917

Table VI. The nominal terms approach

IJCOMA 20,1

58

To quantify the responses of the corporations, which consider ination, the following percentages were attached to each alternative: always (100 per cent), often (approximately 75 per cent), sometimes (approximately 50 per cent), and rarely (approximately 25 per cent). The results reveal that the weighted average response (as a percentage) is approximately 73 per cent. These results indicate that 52.8 per cent of the JIC often consider ination in project evaluations. To investigate whether ination is misapplied, respondents were asked two questions. The rst is to indicate whether they use cash ows expressed in current prices with no adjustment for ination, cash ows expressed in real terms, or cash ows adjusted by the expected rate of ination. The second is to indicate whether they use a real or a nominal discount rate. There were 26 out of the 28 corporations, who indicated that they consider ination, answered both of the questions. The answers are summarised in Table VIII. The italic numbers represent the numbers of corporations who misapply ination in the capital budgeting decisions. The total of these numbers is 18 corporations. That means 18 out of 26 corporations or 69 per cent, who use methods of dealing with ination, treat ination incorrectly. Discounting cash ows expressed in current prices with no adjustment for ination or cash ows expressed in real terms by a nominal discount rate results in an underestimation of projected cash ows, which may lead to rejecting protable projects. Meanwhile, discounting cash ows adjusted by the expected rate of ination by a real discount rate may result in an overestimation of the projected cash ows, which may lead to accepting unprotable projects. Risk analysis techniques One important area in the capital budgeting decisions is the assessment of risk. The results of the current study show that 32 corporations or 60.4 per cent of the corporations surveyed implement risk analysis when making their investments decisions. About
Year 0 1 2 3 4 5 Cash ows current prices ($) 50,000 14,400 18,500 12,500 9,400 6,500 Discount factor@ 12% 1 0.892857143 0.797193878 0.711780248 0.635518078 0.567426856 Present value ($) 2 50,000 12,857.14 14,748.09 8,897.253 5,973.87 3,688.275 2 3835.37

Table VII. The misapplication of ination

Real discount rate Cash ows expressed in current prices with no adjustment for ination Cash ows expressed in real terms Cash ows adjusted by the expected rate of ination Total is 26 corporations 1 4 11

Nominal discount rate 2 5 3

Table VIII. Treatment methods of ination

39.6 per cent of the corporations do not implement this type of analysis. The two main reasons for not implementing risk analysis are: the unfamiliarity with the risk analysis approaches (50 per cent) and the lack in staff, time, and experience for formally analysing risk (45 per cent). There are only 5 per cent of the corporations that do not believe that such approaches could change their prot substantially. This indicates that the JIC are aware of the importance of risk analysis but because of some limitations, they do not employ these approaches in their decisions. Respondents were asked to determine which of four risk assessment methods is used. The four methods are sensitivity analysis, scenario analysis, decision-tree analysis, and total risk analysis. The results also show that corporations do not rely on one type of analyses. A total of 22 corporations, or 68.8 per cent of the corporations, who implement risk assessment, indicated that they use more than one method in their evaluation. Respondents were also asked to determine how frequently they use the four risk assessment methods above. Table IX shows the number and the percentage of the corporations use each risk assessment method in each alternative on the scale. It can be seen from the scores shown in Table IX that total risk analysis is the most used method to analyse risk in the capital budgeting decisions made by the JIC. Total risk consists of systematic and unsystematic (diversied) risks. One can infer from this result that the respondents in general do not diversify their portfolios or they do not assume that they diversify their portfolios. We can conclude from this result that total risk of an individual investment is not important to a corporation, which selects a diversied portfolio. The projects impact on nancial accounting Financial accounting is concerned with identifying, recording, and communicating information regard the historical economic events of a corporation. Therefore, the implementation of the capital budgeting decisions will indeed affect the nancial performance of the corporation. However, one may ask whether the decision maker should take this effect in consideration. Theoretically, we argue that when there is a conict between the results of a capital budgeting decision and the effect on the nancial performance, the decision maker should ignore that effect. To clarify this point of view, let us assume that exchanging a machine will result in a nancial loss, but the project of exchanging that machine has a positive net present value. In this case, it will be, on the long run, for the interest of the corporation to exchange that machine. It is a well-known knowledge for the academicians that historical costs are irrelevant. However, for the managers, ignoring this effect would have a negative impact on their positions. That is because the corporations
Some times n p (%) 4 7 9 3 12.5 21.9 28.1 9.4

Capital budgeting practices 59

Analysis Sensitivity Scenario Decision-tree Total risk

Always n p (%) 5 3 4 14 15.6 9.4 12.5 43.7

Often n p (%) 9 5 4 11 28.1 15.6 12.5 34.4

n 3 1 1 0

Rarely p (%) 9.4 3.1 3.1 0

n 11 16 14 4

Never p (%) 34.4 50 43.8 12.5

Score (%) 41.4 30.0 33.6 67.9 Table IX. The frequencies of using risk assessment analyses

IJCOMA 20,1

stakeholders generally evaluate the management depending on the short-term results rather than the long-term results. In the current study, the respondents were asked whether they consider the projects impact on nancial accounting performance measures. The results revealed that 33 out of 50 corporations or 66 per cent answered that their capital expenditure decisions are affected by the performance of nancial accounting. Other aspects of the capital budgeting decision The discussion above concentrates on using quantitative measurements when making the capital budgeting decisions. Although these measures are important, a good manager would not ignore the qualitative factors that affect his decision in hand, because qualitative factors are as important as quantitative factors. To investigate to which extent the decision maker in the JIC takes into consideration the qualitative factors, the respondents were asked two questions. One to examine whether there are any qualitative factors that affect capital investment decisions. The other to rank six qualitative factors in the order of most to least important. These factors are strategic planning, social responsibility, employee morale, employee responsibility, corporate image and market share. To quantify the responses, the following percentages were attached to each factor as a score: (100 per cent) if a factor is the most important for the corporation, (83.3 per cent) if it is the second, (66.6 per cent) if it is the third, (49.9 per cent) if it is the forth, (33.2 per cent) if it is the fth, (16.5 per cent) if it is the least important, and (0 per cent) if the factor was not chosen by the corporation. Responses to the rst question reveal that 41 out of 51 corporations or 80.4 per cent stated that their decisions are affected by qualitative factors. Responses to the second question show that strategic planning is the most important qualitative factor that affects their capital budgeting decision. Table X summarises these results. The respondents were also asked whether they use any computer technology in evaluating investment projects. Only ten out of 53 corporations or 19.6 per cent stated that they use such technology. To examine the tax considerations for capital investment projects, the respondents were asked to specify whether they use a before-taxes basis or an after-taxes basis to determine the cost of capital and to estimate cash ows of proposed capital investments. In total of 33 corporations or 67.3 per cent said that they use a before-taxes basis and 16 corporations or 32.7 per cent said that they use an after-taxes basis. The results also show that 75.5 per cent of the corporations use the same basis to determine both the cost of capital and cash ows. Meanwhile, 24.5 per cent of the corporations use one of the two bases to determine the cost of capital and the other to estimate the cash ows. This result suggests that the respondents deal with taxation consistently. Post-auditing capital budgeting decision is one of the important aspects of the capital budgeting aspects that should be considered. The purpose of this audit is to compare the completed projects with the originally approved ones. It aims to provide

60

Table X. Importance of qualitative factors

Strategic planning 65%

Social responsibility 36%

Employee morale 25%

Employee responsibility 36%

Corporate image 48%

Market share 3%

Other 3%

management with information regard realistic of the planning stage and why any variances occurred. The results of the study show that 42 out of 50 corporations or 84 per cent carry out post-audit procedures. This result indicates that the JIC are concerned with improving their planning and decision making in the capital budgeting process. Conclusions and recommendations The main purpose of this study is to investigate the techniques used to evaluate the capital projects in the JIC. The results revealed that two-thirds of the respondents use at least one method to evaluate capital projects. The results also showed that respondents do not relay on one technique. However, the results did not reveal that discounted or undiscounted cash ow methods are preferred over the other methods. On other words, the JIC give almost equal importance to the discounted and undiscounted cash ow methods in evaluating capital investments projects. The protability index technique was the most frequent used technique followed by the payback period. In addition, the researchers examined how the JIC deal with related capital budgeting issues. It was found that three quarters of the JIC use a formal method to determine the cost of capital. The most used denition of the cost of capital was the cost of equity capital. In addition, more than 60 per cent of the corporations implement risk analysis when making their investments decisions. The most used approach to assess risk was the total risk. Moreover, the results revealed that more than 80 per cent of the respondents aware of the qualitative factors while taking the capital budgeting decisions. The most important qualitative factor was strategic planning. The results also showed that more than three quarters of the respondents use the same tax basis to determine both the cost of capital and cash ows. Finally, the results showed that 84 per cent of the JIC carry out post-auditing capital budgeting decisions. On the other hand, it appears that there are some misapplications. For example, the results showed that the JIC treat ination incorrectly. It should be emphasized that only half of these companies consider ination when planning for the capital expenditures. It was also found that two-thirds of the JIC consider the impact of the capital budgeting decisions on nancial accounting measures. In addition, it was found that more than 80 per cent of the corporations do not use any computer technology in evaluating investment projects. It seems that there are two main reasons behind the pitfalls in evaluating the capital projects of the JIC. The rst reason is the unfamiliarity with the different techniques used to evaluate those projects. The second is the lack in staff, time, and experience for formally dealing with capital budgeting expenditures. Therefore, the study recommends that: . Managers in JIC should consider the ination factor when they make the capital budgeting decisions. . Managers should be aware of the practical methods for calculating the weighted average cost of capital. For example, using the CAPM model to calculate the required rate of return for equity funds. . Adopting integrated and a comprehensive capital budgeting process as an organizational culture. . Integrate qualitative and quantitative factors capital budgeting decisions.

Capital budgeting practices 61

IJCOMA 20,1

62
.

Using information technology and its applications in the capital budgeting process. Training courses be held to increase the capabilities of the Jordanian corporations personnel. Encouraging chief nancial ofcers to hold professional certicates in accounting. The respondents were asked whether they hold such certicates. The answers revealed that only 21.2 per cent hold at least one of the professional certicates in accounting. The Central Bank of Jordan make the information related to the ination rates more available, understandable and timeliness.

References Amman Stock Exchange (2004), Investing in Your Future, Amman Stock Exchange, Amman. Central Bank of Jordan (2004), Monthly Statistical Bulletin, Vol. 40 No. 7. Central Bank of Jordan (2006), Annual Report 43, Central Bank of Jordan, Amman. Chan, Y.C.L. (2004), Use of capital budgeting techniques and an analytic approach to capital investment decisions in Canadian municipal governments, Public Budgeting & Finance, Vol. 24 No. 2, pp. 40-58. Drury, C. and Tayles, M. (1996), UK capital budgeting practices: some additional survey evidence, The European Journal of Finance, Vol. 2, pp. 371-88. Drury, C. and Tayles, M. (1997), The misapplication of capital investment appraisal techniques, Management Decision, Vol. 35 No. 2, pp. 86-93. Farragher, E.J., Kleiman, R.T. and Sahu, A.P. (2001), The association between the use of sophisticated capital budgeting practices and corporate performance, The Engineering Economist, Vol. 46 No. 4, pp. 300-11. Hilton, R.W., Maher, M.W. and Selto, F.H. (2000), Cost Management: Strategies for Business Decisions, McGraw-Hill, Boston, MA. Hogaboam, L.S. and Shook, S.R. (2004), Capital budgeting practices in the US forest products industry: a reappraisal, Forest Products Journal, Vol. 54 No. 12, pp. 149-58. Jordan Securities Commission (2002), The Securities Law No. (76), The Ofcial Gazette No. 4579, Ministry of Finance, Amman, p. 6218. Kester, G.W. and Tsui, K.C. (1998), Capital budgeting practices of listed rms in Singapore, Singapore Management Review, Vol. 20 No. 1, pp. 9-23. Kester, G.W., Chang, R.P., Echanis, E.S., Haikal, S., Isa, M.M., Skully, M.T., Tsui, K.C. and Wang, C.J. (1999), Capital budgeting practices in the Asia-Pacic region: Australia, Hong Kong, Indonesia, Malaysia, Philippines, and Singapore, Financial Practice and Education, Vol. 9, pp. 25-33. Lazaridis, I.T. (2004), Capital budgeting practices: a survey in the rms in Cyprus, Journal of Small Business Management, Vol. 42 No. 4, pp. 427-33. Payne, J.D., Heath, W.C. and Gale, L.R. (1999), Comparative nancial practice in the US and Canada: capital budgeting and risk assessment techniques, Financial Practice and Education, Vol. 9, pp. 16-24. Ross, S.A., Westereld, R.W. and Jaffe, J.F. (2002), Corporate Finance, McGraw-Hill, Boston, MA.

Ryan, P.A. and Ryan, G.P. (2002), Capital budgeting practices of the Fortune 1000: how have things changed?, Journal of Business and Management, Vol. 8 No. 4, pp. 355-64. Welsch, G.A., Hilton, R.W. and Gordon, P.N. (1988), Budgeting: Prot Planning and Control, Prentice-Hall, Englewood Cliffs, NJ. Corresponding author Basheer Ahmad Khamees can be contacted at: basheer@ju.edu.jo

Capital budgeting practices 63

To purchase reprints of this article please e-mail: reprints@emeraldinsight.com Or visit our web site for further details: www.emeraldinsight.com/reprints