Capital Budgeting Practices 86
Capital Budgeting Practices of Twelve Large Manufacturers
Marc Ross, University of Michigan,
reprinted from Financial Management (winter 1986) vol. 15, issue 4, pp 15-22
Surveys of capital budgeting practices among lrge firms have indicated a widespread use
of discounted cash flow (DCF) methods, especially internal rate of return.
At the same time,
many firms state that they also continue to use simple payback or related methods . The study
reported here sheds light on the differences between theory and practice in the implementation of
Surveys have shown hat 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.
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 thee capital allocation practices.
A. The Alliance Study
The study, by the Alliance to Save Energy , was undertaken to evaluate tax incentives
for industrial energy conservation. I was supported by the John D. and Catherine T. MacArthur
Foundation. Data were gathered, in 1982-82, from 15 large firms, with three each from the steel,
paper, chemical, aluminum, and petroleum refining industries. Since the author did not
participate in the petroleum refining interviews, petroleum refining is omitted here. The firms
studied account for about one-third of the combined sales of the four industries. Much of the
information is proprietary and the firms cannot be identified.
The author would like to express his pleasure in working with the project group at the Alliance to Save Energy:
Robin Miller, Bob Rauch, Mike Reid and Jim Wolf; Carliss Baldwin of the School of Business Administration,
Harvard University, for extensive comments on an early draft; and the editor of Financial Management for extensive
Two recent surveys of the literature are those by Scott and Petty  and Gurnani .
See the surveys by Gitman and Forrester  and Petty, Scott and Bird . A survey of capital budgeting practices
is presented by Fremge .