Importance of Capital Budgeting decisions

Capital budgeting decision is a vital part of financial management, as it involves huge capital investment. Many researches have been undertaken in this field to know the best method of Capital budgeting decision. The result of some of the literature review and surveys shows the following results:

Research conducted by Uma.V Sridharan and Ulrich Schuele (2008) about the Capital Budgeting decisions of German Managers shows that small firms prefer payback period method as the best method and Internal Rate of return is regarded as the second best capital budgeting evaluation method. While the large firms prefer NPV method as the best and the second best method is internal rate of return method. Even in case of risk factors both high risk & low risk firm prefer NPV and IRR methods.

The study conducted by Alaba Femi Awomewe & Oludele Olawale, Ogundele (2008) also shows the importance of payback period method in capital budgeting decisions.

The study conducted by Shimin Chen (2008) also shows the importance of discounted cash flow method especially NPV and IRR.

Thus we can conclude the best method for evaluating the investment project is NPV and IRR. Small firms can use payback period method just to know the time required to get back the money invested. Also it is simple and easy to use.

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