Original Research

Capital budgeting practices in South Africa: A review

C. Correia
South African Journal of Business Management | Vol 43, No 2 | a180 | DOI: https://doi.org/10.4102/sajbm.v43i2.180 | © 2018 C. Correia | This work is licensed under CC Attribution 4.0
Submitted: 13 April 2018 | Published: 29 June 2012

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C. Correia, College of Accounting, University of Cape Town, South Africa

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Abstract

This paper reviews the capital budgeting survey literature in South Africa over the period 1972 to 2008. The survey evidence indicates a significant growth in Discounted Cash Flow (DCF) methods and a fall in the use of other methods. In particular, there has been growth in the use of Net Present Value (NPV). Yet, the Internal Rate of Return (IRR) technique remains the primary method used in practice despite some serious drawbacks. Larger companies are more likely to use DCF methods. There has been a significant growth in the use of sensitivity analysis and scenario analysis. However, there is little use of sophisticated risk analysis tools such as Monte Carlo simulation, and decision trees. Although financial theory predicates the use of risk adjusted discount rates, surveys indicate that the majority of companies use a single firm discount rate. Companies have increasingly used inflation-adjusted cash flows but the process of ranking mutually exclusive projects is not aligned with finance theory. There is limited use of the Modified Internal Rate of Return (MIRR) method and DCF dominant companies do not outperform non-DCF dominant companies. The most important phase of project evaluation is the project definition and cash flow estimation phase and yet research studies have focused mainly on the financial analysis and project selection phase.

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