Capital budgeting more important

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1.0. Introduction

1.1 Research Background

1.2 Objective of the Study

1.3 Arrangement of the Subsequent Sections of the Dissertation

2.0 Literature Review

2.1 Theories of capital budgeting techniques

2.2 Capital Budgeting Practice

2.2.1Capital budgeting Practice in China and Other Asian Countries

2.2.2 Capital Budgeting Practice in Western Countries

2.3Summary

Chapter 3: Methodology

3.1 Research Design

3.2Survey Sample and Questionnaire

3.3Description of Data

3.4Summary

Chapter 4: Results and Data Analysis

4.1 Quantitative Investment Evaluation Methods

Exhibit1 Sample description-Size of the companies

Exhibit 2 Sample description-Sectors of the companies

Exhibit3Techniques applied in practice

Exhibit 4 Ranking the importance of capital budgeting methods

Exhibit 5 Number of methods used in practice

Exhibit 6 Capital budgeting methods used in practice

4.2 Risk Assessment Techniques

Exhibit 7Risk Assessment Techniques

4.3 Discount Rates Used to Evaluate Proposed Capital Investment

4.4 Methods of Estimating the Cost of Equity Capital

Exhibit 8 Definition of WACC

Exhibit 9The method of calculating the WACC

4.5 Income Taxes

Exhibit 10Income Taxes Analysis

4.6 Capital Rationing

Exhibit 11Capital Rationing Analysis-by companies

Exhibit 12Capital Rationing Analysis-by years

4.7 Minimum Size of Projects that Require Quantitative Analysis

Exhibit 13 Expenditure of capital budgeting every year

Exhibit 14 Frequency of conducting post-audits

4.8Summary

Chapter 5: Conclusion

5.1 Conclusions

5.2 Recommendations

5.3 Limitation of the Research

Table of Contents

Capital budgeting is becoming increasingly more important as a kind of managerial tool in recent years (Graham & Harvey 2001). Capital budgeting is a key issue in corporate finance (Brigham, 1992). Over several decades, major theoretical developments in capital budgeting have been incorporated into corporate practice (Graham & Harvey 2001). It is over four decades since one of the key developments: Sharpe’s (1964) publication of the capital asset pricing model (CAPM). American evidence suggests that the adoption of the CAPM in the practice of capital budgeting has been widespread (Brigham, 1992). One responsibility of the financial manager is to choose investments with satisfactory cash flows and rates of return. Therefore, a financial manager must be able to decide whether an investment is worth undertaking and be able to choose intelligently between two or more alternatives (Arnold &Glen. 2000). To do this, a procedure to compare, evaluate, and select projects is needed. This procedure is called capital budgeting. The selection and employment of processes and techniques to decide major financial commitments are crucial. Making optimum capital budgeting decision (e.g., whether to accept or reject a proposed project), often requires recognizing and correctly accounting for potentialities associated with the project. Inadequate evaluations and decision tools risk the possibility of applying scarce resources to areas which provide a return less than the cost of capital, resulting in a destruction of value (Brigham, 1992). Therefore, capital budgeting and the estimation of the cost of capital are two of the most important financial decisions facing financial managers. In this study, it will provide direct empirical evidence on the capital budgeting process based upon a recent survey of a number of small and medium sized Chinese corporations.

Many formal methods are used in capital budgeting, including the techniques such as net present value, profitability index, internal rate of return, and so on (Cooper, 2001). These methods use the incremental cash flows from each potential investment, or project. Techniques based on accounting earnings and accounting rules are widely used, such as the accounting rate of return, and return on investment, though some economists and accountants consider this to be improper (Graham & Harvey 2001). Simplified and hybrid methods are used as well, such as payback period and discounted payback period.

Capital budgeting can be broadly defined as systematic evaluation of how much capital to invest in one project or asset and the specific assets companies should use to meet their investment objectives (Graham & Harvey 2001). Capital investments are often described in the financial literature as long-term investments. Long-term investments are difficult to manage because an assessment of risk and uncertainty must be made. Furthermore, potential and actual capital budgeting success is determined by evaluation through forecasting and monitoring (Seitz and Ellison, 1999). Companies routinely deal with the investment of capital. Choosing appropriate capital budgeting methods and strategies for investment decisions in assets is essential for success in the industry as the correct strategy can assist in maintaining or increasing profit margins, market share and competitive advantages.

Capital budgeting decisions are crucial to a firm’s success for several reasons. First, capital expenditures typically require large outlays of funds. Second, firms must ascertain the best way to raise and repay these funds. Third, most capital budgeting decisions require a long-term commitment. Finally, the timing of capital budgeting decisions is important (Brigham, 1992).

The aim of this study is to identify the capital budgeting practices adopted in China. The research will focus on a survey of capital budgeting practices in a sample of small and medium sized Chinese corporations. The survey will collect, present, and analyze data regarding the practical application of capital budgeting methods in Chinese firms. And data will also be collected on what method is used, how it is applied and why it is chosen, and whether it is used properly. The study will also identify specific reasons why they use the capital budgeting method.

In spite of the importance of small business firms, most of the literature and surveys related to capital budgeting are targeted toward larger firms. This dissertation focuses on the smaller firms. The intent of this study is to ascertain where small firms stand today in regard to capital budgeting techniques as opposed to prior decades. This research explains budgeting models currently being used by small and medium companies in China and the methods used to adjust for risk. Since small firms are a significant source of job creation, it is important to better understand their techniques even if they don’t always conform to the normative approach.

Capital budgeting and the estimation of cost of capital are two most important financial decisions facing financial managers (Arnold, 2000). Several capital budgeting techniques are available to assist firms in evaluation of a capital budgeting project. The literature indicates that there is a gap between the theory and practice of capital budgeting (Cooper, 2001). For example, some managers may prefer the Internal Rate of Return over the Net Present Value as an investment decision making tool while business scholars prefer NPV (Graham & Harvey 2001). So it is important to discover the application of capital budgeting. This study considers the small and medium firms instead of large companies because of the importance of capital budgeting methods for the decision making of these companies. China is chosen as the research site in order to understand Chinese businesses and recent developments. Great changes have taken place in China with the development of economic environment (Kester, 1999). Chinese firms are trying to study advanced techniques and theory from western countries to improve their operating performance since 1990s (Hermes, 2007). They also compare their situation with foreign countries to have a better understanding of the limitation of their practice. Therefore, research on capital budgeting practice in China could contribute to the development of policy approaching to the international practice, especially for some small and medium firms.

The paper is organized as follows. In section 2, relevant literature to the study is reviewed. Section 3 describes the survey questionnaire, survey sample and survey process. Section 4 provides the survey results and statistical analysis. Section 5 concludes the paper and indicates the limitations of the study.

The section is organized as follows. In section 2, relevant literature to the study is reviewed. The first part of this section discusses several popular capital budgeting techniques which are often introduced in theory. These techniques are also related to the section 4, i.e. results analysis and questionnaires in the survey. The second part describes a number of different surveys and gives some comments. It also discusses the relationship between these literatures and this study.

Capital budgeting decisions are very important and complex and have inspired many research studies. The literatures in early years indicated the nature of capital budgeting which could be helpful to understand capital budgeting theoretically. Capital budgeting is investment decision-making as to whether a project is worth undertaking. Capital budgeting is the planning process used to determine whether a firm’s long term investments are worth pursuing (Stulz, 1999). Capital budgeting is basically concerned with the justification of capital expenditures. The argument that capital is a limited resource is true of any form of capital, whether debt or equity, accounts payable or notes payable, and so on (Segelod, 1998). In reality, any firm has limited borrowing resources that should be allocated among the best investment alternatives. One might argue that a company can issue an almost unlimited amount of common stock to raise capital. However, as the number of shares of a company increases, the company ownership of the individual stockholder may proportionally decrease, which is not expected by shareholders of the firms. The argument that capital is a limited resource is true of any form of capital, whether debt or equity (short-term or long-term, common stock) or retained earnings, accounts payable or notes payable, and so on. Even the best-known firm in an industry or a community can increase its borrowing only up to a certain limit. Once this point has been reached, the firm will either be denied more credit or be charged a higher interest rate, making borrowing a less desirable way to raise capital.

Faced with limited sources of capital, managers should carefully decide whether a particular project is economically acceptable. In the case of more than one project, management must identify the projects that will contribute the most to profits and, consequently, to the value or wealth of the firm. This, in essence, is the basis of capital budgeting (Segelod, 1998).

There are some capital budgeting techniques which are commonly used to evaluate capital budgeting projects, for example, the payback which simply determines the length of time required for the firm to recover its cash outlay, accounting rate of return, net present value, and internal rate of return, discounted cash flow method, and book value. Some of these capital budgeting techniques which would be referred in the questionnaire and data analysis section to were selected to be discussed in this part in order to help understand both advantages and disadvantages of these techniques. It is also helpful to understand why companies choose to the corresponding capital budgeting techniques instead of others.

The payback model measures the amount of time required for cash income from a project to exactly equal the initial investment. The accounting rate of return is the ratio of the project’s average after-tax income to its average book value (Zhang Suyun, 2007). Academicians criticize both the payback and the accounting rate of return models because they ignore the time value of money and the size of the investment. And the payback model does not consider returns from the project after the initial investment is recovered.

For IRR method, a number of surveys have shown that, in practice, the IRR method is more popular than the NPV approach. The internal rate of the return model equates the cost of the project to the present value of the project. The internal rate of return models overcomes the time value of money deficiency. However, this capital budgeting method fails to consider the size of a project. The reason might be that the IRR is clarifying, but it uses cash flows and recognizes the time value of money, like the NPV. In other words, while the IRR method is easy and understandable, it does not have the drawbacks of the ARR and the payback period, both of which ignore the time value of money. The main problem with the IRR method is that it often gives unrealistic rates of return. So unless the calculated IRR is a reasonable rate for reinvestment of future cash flows, it should not be used as a yardstick to accept or reject a project. Another problem with the IRR method is that it may give different rates of return (Segelod, 1998).

When the net present value model is used, the firm discounts the projected income from the project at the firm’s minimum acceptable rate of return (hurdle rate). The net present value is the difference between the present value of the income and the cost of the project. If the net present value of the project is positive, the project is accepted; conversely, if the net present value is negative, the project is rejected. The greatest problem with the traditional present value methods, however, is that the entire decision must rest upon quantifiable cash flows (Zhang Suyun, 2007). In today’s high-tech environment, many new projects involve total redesign of the manufacturing environment. Although managers know that they must develop fully computerized design and manufacturing systems to be competitive in this fast-moving world, it is difficult if not impossible to quantify all of the benefits of such systems (Brigham, 1992).

In the critique of capital budgeting theory, Booth (1996) describes estimation issues managers must confront when implementing discounted cash flow analysis. He concludes that discounted cash flow analysis is less valuable when the level of future cash flows is more uncertain. According to this view, discounted cash flow analysis can be applied most directly to projects with cash flow profiles similar to the firm’s current operations (such as projects extending those operations). Discounted cash flow analysis will be less valuable to evaluate ventures that are not directly related to current activities.

Although Booth developed these ideas for large multinational corporations, they can also be applied to small firms. If a small firm is considering investment in a new product line, future cash flows cannot be estimated directly from the past performance of the firm’s current operations. In addition, because of the firm’s scale, market research studies to quantify future product demand (and cash flows) might not be cost effective. For these reasons, small firms may not rely exclusively on discounted cash flow analysis when evaluating investments in new product lines (Booth, 1996).

Facing the complex nature of today’s projects, some new methods were created, such as multi-attribute decision models and the analytical hierarchy process. These models could incorporate the softer measures into the decision process to some extent. These approaches weigh and rate for importance, impact, and probability all factors that can be identified as relevant, from the ones that can be measured to those that are more subjective (Brigham, 1992).

The profitability index is a ratio of the project’s value to its initial investment. The firm then selects the project with the highest profitability index and continues to select until the investment budget is exhausted. The profitability index overcomes both the time value of money and the size deficiencies (Zhang Suyun, 2007). Some decision makers have criticized the net cash flow method because they simply do not agree with the decisions indicated by the results from the models. In some cases, managers are reluctant to make important decisions based on uncertain estimates of cash flows far in the future. Thus, they consider only near-term cash flows or are distrustful of the output of the models. In others, managers may have predetermined notions about which projects to adopt and may, therefore, "massage" the numbers to achieve the result they desire. Thus, in many cases, the negative results occurred because of inappropriate input into the models, rather than from the models themselves (Tsui Kal Chong et al., 1998).

Several researches have been done by a number of scholars these years. Most of them surveyed a list of companies in different countries including China, and other Asian countries and made a comparison. The survey which was conducted by Hermes, Niels et al in 2007 compares the use of capital budgeting techniques of Dutch and Chinese firms, using data obtained from a survey among 250 Dutch and 300 Chinese companies. They analyzed the use of capital budgeting techniques by companies in both countries from a comparative perspective to see whether economic development matters. According to their empirical analysis based on the data collected, Dutch chief financial officers on average use more sophisticated capital budgeting techniques than Chinese CFOs do to some extent. At the same, however, their results also suggest that the difference between Dutch and Chinese firms is smaller than might have been expected based upon the differences in the level of economic development between both countries, at least with respect to the use of methods of estimating the cost of capital and the use of CAPM as the method of estimating the cost of equity. They selected a number of Chinese companies and did the questionnaire of the capital budgeting practice in each firm. They provided valuable information about the application of capital budgeting method in China which could be considered as references in this study.

Similar research was done by Kester, George W. et al (1999).In their paper it reported the results of surveys of executives of companies in six countries in the Asia-Pacific region, Australia, Hong Kong, Indonesia, Malaysia, the Philippines, and Singapore regarding their companies’ capital budgeting practices. They surveyed the executives of companies listed on the Australian Stock Exchange, Stock Exchange of Hong Kong, Jakarta Stock Exchange, Kuala Lumpur Stock Exchange, Philippine Stock Exchange, and Stock Exchange of Singapore by using mail questionnaires to obtain the information they want. According to their survey results, one of the issues facing multinational corporations is the consistency of managerial practices across countries. To the extent that practices differ, multinational companies must incur costs to train employees and implement new practices. Their results regarding quantitative evaluation techniques indicate that the practices of companies in the surveyed countries of the Asia-Pacific region are similar to their Western counterparts. Executives from the surveyed countries consider discounted cash flow techniques such as NPV and IRR to be more important than non-discounted cash flow techniques for evaluating and ranking capital investment projects. They also expressed a preference for using scenario and sensitivity analysis to assess risk, which is also consistent with practices in the West. However, when selecting the discount (hurdle) rates used for project evaluation, the practices of companies differed across the surveyed countries. In their findings, it is noticeable that they found the practices conflict with a basic principle of finance theory, which the return required on an investment, should reflect the risk ness of the investment and the return available elsewhere from investments of similar risk (George W. Kester, 1999). Their research is helpful and similar to this study. Though they use comparisons between different countries, the areas which were focused on and the questions in the questionnaire are similar, which could give a good direction for this research.

The study which was conducted by Tsui Kal Chong et al. (1998) focuses on capital budgeting practices of listed firms in Singapore. The paper reports the results of a survey on executives of listed firms in Singapore regarding their firms’ capital budgeting practices. The survey questionnaires included such topics as quantitative investment evaluation techniques, risk assessment, discount rates, cost of equity capital, and capital rationing, which is similar with this study. The paper extends these studies to include a third major area of corporate financial policy capital budgeting. Executives of large corporations in the U.S. have been extensively surveyed in their study regarding their companies’ capital budgeting practices, especially during the seventies and eighties. These surveys, which have focused upon techniques of evaluating project profitability and risk, have shown that the sophistication of the analytical techniques used by U.S. executives have increased over time (Tsui Kal Chong et al., 1998). Similar research conducted by Block (2001). Their study included a questionnaire survey of 232 small business firms in Singapore and illustrated that capital budgeting techniques are still important for small firms, and the primary method is payback method. At the same time, their research methods, including design of the questionnaire and data analysis method, are similar to this study. Therefore, this research could be used as guidance and reference for this study.

This research conducted by Majidul Islam in 2005 examines the development of management accounting practices in China including capital budgeting techniques and other areas from the perspective of transitional economies. The paper attempts to analyze the development of capital budgeting practices and management accounting practice in Chinese business by looking at the background and contemporary thoughts. However, their discussion was aligned to empirics from other research and existing literature. Their evidence suggests that the national culture and values practiced for centuries by Chinese business influence the concerted efforts for information dissemination and developing capital budgeting practices. Because of the lack of understanding of western management accounting practices, the pace of development of Chinese management accounting practices might be slow for now. It also examines the evolution of management accounting systems in China, with their distinctive features, in order to provide a better understanding of their development. This paper could be seen as a combination with theory and practice. It gave a clear view of the developments of capital budgeting practice and other areas in China from 1990s to 2000s, which is helpful for understanding this research.

A number of studies, which were conducted few years ago, examine the methods that firms’ managers used to analyze projects. Most studies focused on European countries and the US and focused on larger companies rather than small firms.

Despite the importance of small and medium companies, most of the research and surveys related to budgeting are targeted towards larger firms. However, Sagner, James S. (2007) argued that methods appropriate for small business firms might differ from those applied to large firms. He also suggests that capital budgeting may be more important to small firms than larger ones because of their lack of access to the public markets for funding in a smaller firm. These kinds of research have a close relationship with the dissertation.

Laurence G. Gitman and John R. Forrester Jr. analyzed the responses from 110 firms who replied to their survey of the 600 companies that Forbes reported as having the greatest stock price growth over the 1971-1979 periods. The survey containing questions concerning capital budgeting techniques, the division of responsibility for capital budgeting decisions, the most important and most difficult stages of capital budgeting, the cutoff rate and the methods used to assess risk. They found that the discounted cash flow techniques were the most popular methods for evaluating projects, especially the internal rate of return. However, many firms still used the payback method as a backup or secondary approach. The majority of the companies that responded to the survey indicated that the Finance Department was responsible for analyzing capital budgeting projects. Respondents also indicted that project definition and cash flow estimation was the most difficult and most critical stage of the capital budgeting process. The majority of firms had a cost of capital or cutoff rate between 10 and 15 percent, and they most often adjusted for risk by increasing the minimum acceptable rate of return on capital projects (Gitman, 1977).

Numerous capital budgeting surveys have been conducted overseas (e.g. Block 1997, Graham & Harvey 2001, Arnold & Hatzopoulos 2000). These surveys found that discounted cash flow based techniques such as internal rate of return and net present value methods were dominant and the capital assets pricing module was the most popular approach to estimating the cost of capital. Graham and Harvey (2001) found that internal rate of return and net present value were the most frequently used capital budgeting techniques. Other techniques such as the payback period were less popular, but were still being used by a majority of companies. Zhang Suyun(2007) found that the payback method was preferred by small firms. Despite being advocated by academics as a method that could supplement and overcome the limitations of discounted cash flow methods, real options techniques were relatively unpopular; they ranked eighth among twelve techniques considered by Graham and Harvey. Even so, 27% of respondents reported using real options techniques. Graham and Harvey found that the CAPM was the most popular method of estimating the cost of equity with 73% of respondents relying mainly on the CAPM. Compared to two previous surveys of US companies, Gitman and Mercurio (1982) and Gitman and Vandenberg (2000), the CAPM had increased in popularity. An increase in the alignment of the capital budgeting practice of US firms with academic prescriptions was also observed by Ryan and Ryan (2002).

In an in-depth study of the capital budget projects of twelve large manufacturing firms, Marc Ross found in 1972, that although techniques that incorporated discounted cash flow were used to some extent, firms relied rather heavily on the simplistic payback model, especially for smaller projects. In addition, when discounted cash flow techniques were used, they were often simplified. For example, some firms’ simplifying assumptions include the use of the same economic life for all projects even though the actual lives might he different. Further, firms often did not adjust their analysis for risk (Ross, 1986).

An international survey that included Australian companies in the sample, among companies from six Asia Pacific countries, was undertaken by Kester et al. (1999). This survey confirmed the popularity of discounted cash flow methods in Australia and the popularity of the CAPM, which was used by 73% of the companies surveyed; information on the use of the CAPM was not included in previous surveys in Australia. The rate of CAPM usage was significantly higher than in the other Asia Pacific countries surveyed, which covered Hong Kong, Indonesia, Malaysia, the Philippines and Singapore.

The surveys in Australia, as well as in other countries, show that the DCF approach has become the most popular technique for making capital budgeting decisions in public companies (Giang Truong, 2008). Nevertheless, rule of thumb techniques continue to enjoy substantial use. The WACC is widely used as a discount rate and the CAPM is the most popular method used when estimating the cost of equity. These practices accord reasonably well with the prescriptions of corporate finance textbooks. In overseas surveys, the CAPM was found to be the most popular method used in the estimation of the cost of capital. The payback period was a more popular technique than the IRR and NPV methods. The study also reported a higher usage of the real options technique than was found by Graham and Harvey, with 29% to 53% of firms in European countries that used real options when evaluating a project.

This section gives a good overview of relevant literatures in the past decades which have similar research area in this study. It is also helpful to understand the design and analysis of later research. All in all, capital budgeting techniques are increasingly important because of their function on investment decision making and project evaluations. Scholars and managers pay much more attention to them, no matter in large listed companies or small and medium sized companies. Though the election of capital budgeting methods could be different, the importance of capital budgeting techniques in companies’ success is accepted by most of people. Compared with research in 1980s or before, scholars and managers began to focus on capital budgeting practice rather than only theories. Integration and comparison of theories and practice could be found in most recent literatures. While this section gives a brief overview of these literatures and surveys in different areas, the next section will discuss the research method and design of the questionnaire based on the reviews in this section.

The part reviews the survey questionnaire, survey sample and survey process. The first part of this section is mainly about the design of this research, which includes the survey techniques, the process of this survey and the structure of the questionnaire and so on. The second part describes the sample firms and the questionnaire, including how to choose these companies and how to send the questionnaire to the managers of these companies. The last part is the description of the data, which gave an overview of the data collected and used in this study.

Comparing with other methods, the survey technique, which can provide information on beliefs, attitudes and motives, is an efficient tool for collecting data in large amounts at low cost in a short period (Payne, 1999). The questionnaire for the survey were conducted in August 2009 from a sample of small and medium sized firms in China, defined as a business employing at least one individual in addition to the owner, but no more than 249. A list of questions will be asked related to the aims of the study. For example, in the first part of the questionnaire such questions will be asked as whether the managers and accountants of the companies in China choose capital budgeting techniques and how long they have used it. In the second part, managers and accountants of these sample firms will be asked about how capital budgeting technique is applied and why it is chosen, and other details of their capital budgeting practice. For the third part, the managers and accountants of Chinese companies could be asked about whether the application of theory is valid in practice for dealing with the project analysis and investment decisions, and at the same time, they will be asked for some suggestions or questions of this survey. Most of the questions would be closed questions. All the contact details are provided in the invitation which will be sent with the questionnaire. The survey questionnaires will also include such topics as quantitative investment evaluation techniques, risk assessment, discount rates, cost of equity capital, and capital rationing.

The first step of attitude survey is to select a sample. The sample is a set of elements selected from a population to be unbiased estimates of the population in terms of whatever is being researched (Timothy, 2007). There will be about fifty companies as the sample in this study. During collection of data, the returned questionnaires then will be checked and verified for picking out the obvious problems. An in-depth cleaning check will be undertaken to make sure the data set is error-free for the further analysis. In the analysis stage, the study will use descriptive and statistic methods to do analysis according to previous responses. Some software such as Word will be used to help to carry out the statistical analysis.

To construct the survey sample, the 208 firms as of August 2008 were selected as the population of interest. The focus of this survey is the capital budgeting practice of Chinese companies, so foreign-domiciled companies were excluded. Companies in the financial sector were also excluded as the focus here is on capital budgeting decisions for real assets. The final respondents comprise 59 companies in fifteen sectors. The 208 firms were chosen from Chinese database. Companies which have full details including contact information of the companies, introduction and their managers or accountants were chosen. For doing research, financial institutions and large listed companies would not be chosen as sample firms. Furthermore, the sample companies should be found or incorporated in more than ten years because these companies are stable compared with new companies. Limited time and cost was also considered when choosing these sample firms.

Companies’ addresses and the names of chief financial officers, directors of finance, corporate finance managers, or similar finance positions of about 190 companies were obtained from either the WanFang database or the MNC.people website. For some companies, it was not possible to obtain the names of financial officers, or staff in similar positions, and in these cases survey letters were addressed to the ‘Chief Financial Managers.”

Potential respondents were offered the opportunity to obtain the results of the survey. Respondents were also offered the opportunity to make their response anonymous, but a substantial majority chose not to do so. The survey questionnaire was also made available on the server of Survey Monkey and respondents could choose to reply using the online form, or by completing a paper questionnaire that was sent to each company. The majority of respondents chose the former.

The survey questionnaire included about 20 questions, some of which were open-ended. The survey letters were sent out in early August 2009 and about 30 responses were received in the first week. 29 additional responses were received in the second week. This provided a total of 59 responses, of which 52 were completed on the internet and 7 were completed in paper form. The overall response rate was 28.3%, which is generally higher than surveys conducted overseas, but somewhat lower than similar surveys conducted previously in Australia. Freeman and Hobbes (1991), for example, obtained 113 responses from 289 companies, a response rate of 39%.

Some respondents did not answer all questions. Therefore, in the following discussion, the percentage of respondents refers to the percentage of respondents answering the particular question under discussion. The number of actual respondents for a question is given in the table reporting the relevant response.

The use of survey data to document capital budgeting practices has a long history in the finance literature. Yet, survey results should be interpreted with caution because surveys measure manager beliefs, not necessarily their actions; survey participants may not be representative of the defined population of firms; and survey questions may be misunderstood by some participants (Graham and Harvey, 2001, p.189). Nonetheless, surveys provide information that cannot be readily gleaned from financial statements. In particular, surveys can shed light on how firms make investment and financing decisions and why they use these approaches. The data of this research includes both primary and secondary data. The primary data which was collected from sending questionnaires was used to conduct data analysis and evaluations. The secondary data was used to make a comparison with this research, which was obtained from some similar studies in the same research area.

This section generally demonstrates the work done before analysis and conclusion. Though the sample firms are a small part of the total number of firms in China, they are still representative and usable for research. Based on the design and structure of the research, the data that was collected from sending the questionnaire would be analyzed and get results in the next section.

The survey results and statistical analysis were provided in the section based on the information obtained from the previous sections. Each part of this section is related to the corresponding section of questions in the questionnaire. In each part, it firstly describes the questions asked to the managers of the companies, and then analyzes the data collected and provides a result. There may be other surveys provided in this part for comparison which could be helpful to understand the study better.

The first part of the survey was designed to investigate the capital budgeting methods which the companies use in practice in China. One of the primary goals in this study was to determine which of the quantitative investment evaluation techniques are currently used in China. Kida et al. (2001) made a similar survey and they asked executives to indicate which quantitative methods were used in their companies as primary and secondary measures in evaluating proposed capital investments. However, there are some weaknesses of the approach, for example it does not provide information about the weight that executives placed on each method in making final accept-reject decisions. To overcome this weakness, managers were asked to rate the various methods based on the importance of each method. This approach has several advantages. It not only reveals which of the methods are used, it also provides information on the relative importance of each method in decision-making. The results are presented in the table below. The survey data is used to document the capital budgeting practices of small firms and to provide evidence about whether small-firm project evaluation methods are related to the type of investment under consideration.

In the first part of the questionnaire, managers and accountants of the sample firms were asked to provide some information of their companies, which is helpful to understand the companies as well as analyze the data in the study. Because it had set that all the sample firms should answer the first two questions, all the fifty-nine companies provided their answers. Details of size of each company which is related to question one are presented in Exhibit 1. The second question is about the sectors of the companies. The result is presented in Exhibit 2.

Options	Number of companies	Percentage
Up to 500000 RMB	3	5
500001 to 1000000 RMB	7	12
1000001 to 5000000 RMB	12	20
5000001 to 10000000 RMB	16	27
10000001 to 20000000 RMB	14	24
20000001 to 50000000 RMB	5	8
50000001 to 100000000 RMB	2	4
More than 100000001 RMB	0	0
Total	59	100%

From Exhibit 1, it could be clearly seen that all these companies are small and medium sized. There are twenty-two companies which has a capital less than 5000000 Yuan. These firms accounted for 37% of the total firms. And over 50% companies have a capital between 5000000 Yuan and 20000000 Yuan. Only 12% companies are relatively larger and have a capital of more than 20000000 Yuan. However, compared with some large sized companies in China, all these companies are small and medium sized.

Options	Number of companies	Percentage
Energy	1	2
Health care	2	4
Industrials	11	18
Information technology	1	2
Telecommunication services	1	2
Materials	10	17
Utilities	1	2
Mining	0	0
Transportation	5	8
Travel and leisure	3	5
General retailers	5	8
Food and drug retailers	8	13
Chemicals	1	2
Software and company service	7	12
Media	1	2
Forestry and Paper	2	3
Tobacco	0	0
Others	0	0
Total	59	100%

According to the Exhibit 2, there are fifteen sectors among all the fifty-nine companies, which include food and drug retailers, software and company service, transportation and so on. Among all the fifty-nine companies, the ones doing industrial and material are the most, which accounts for 18% and 17% respectively. These are eight food and drug retailers companies and seven software and company service, which accounted for 13% and 12% respectively. None of these companies are doing mining and tobacco. The reason is that there must be certificate of the government and enough capital and safety device for doing these industrial.

In the next part, managers and accountants of these companies were asked to provide some information of their use of capital budgeting techniques in practice. The first question was about whether the company used capital budgeting techniques, currently or in the recent past when making investment and management decisions. As all the fifty-nine companies answered yes, they should all continue to the next question. The reason for these companies answering yes could be that they need the capital budgeting techniques not only to reduce cost of conducting projects but also to understand whether it is worthy to conduct projects. Though they are all small and medium sized business, limited fund force them to thing about how to take advantage of these resource efficiently. Therefore, all of the fifty-nine companies choose to use capital budgeting techniques which could help them to manage their limited fund in a good way. For the second question, respondents were asked to indicate which capital budgeting methods their company uses. And the results are summarized in the Exhibit 3 below.

Techniques	Number of companies	Total	Percentage
Pay back period	49	59	83%
Internal rate of return	25	59	42%
Net present value	40	59	68%
Acct’ g rate of return (ARR)	11	59	19%
Others	0	59	0
Blank	0	59	0
Total	125

The percentage of companies using each evaluation technique is shown in the table above. As this is a multiple choice question, one company could choose several options according to their own practice. From the exhibit, it could be conclude that a lot of managers of these companies choose to use different kinds of capital budgeting techniques for projects evaluation in practice. The detail would be discussed later. The reason for using different methods could be that in many cases, replacing equipment is not a discretionary investment for a small firm; the firm must replace the equipment to stay in business. In some replacement decisions, a small firm may have limited replacement options and differences in the future maintenance costs of the various options can be difficult to forecast, because small firms do not satisfy the assumptions underlying capital budgeting theory. And because of these cash flow estimation challenges, it would be natural for small firms to evaluate projects using different techniques than large firms (Zhang Suyun, 2007). Managers in China ranked NPV and payback as the most frequently used techniques for evaluating projects. This is a similar result as the survey done by Giang et al. (2008). He found that in his survey about 54 percent of project evaluation is done by means of a simplified evaluation technique such as book value and that 37 percent of the companies use the payback period technique. Among the methods that take into account the time value of money concept, the NPV method is the one most companies prefer (11 percent), and only 9 percent of them use IRR. It is also noticeable that about 19 percent of the companies do not use any evaluation method for their investment projects in Giang’s survey.

In the next stage, managers and accountants were asked to indicate the relative importance of the each of the following quantitative techniques used in their firm to rank proposed capital investments and to decide whether or not they should be accepted for inclusion in the capital budget. The results are summarized and ranked according to perceived importance in Exhibit 4.

The results of the present survey tend to confirm the results of the survey by Giang et al. (2008). One difference, however, is that Giang et al. found that the IRR was ranked as being of equal importance to NPV. In our survey, the IRR has lost ground and has a ranking below the payback techniques. According to the data collected, thirty-nine managers of the companies think that payback method is very important or important, while only five managers considered the payback method as very important, and twenty-one managers think it is a important method. Net present value method has also got a high rank compared with other methods. Twenty-seven companies considered it as important and twelve companies ranked it as very important. For ARR method, about twenty-seven managers considered it as moderately important, while only eight managers thought it was important. This suggests that companies are not abandoning rules of thumb, but that they are using them in conjunction with NPV and other techniques.

Most companies did not rely on a single capital budgeting technique but employed a number of techniques in their evaluation process. When respondents were asked about how many capital budgeting methods their company use for making each investment decision, all the manages gave their answers according to their companies’ capital budgeting practice. Assuming techniques ranked moderately important, or higher, were used regularly, about 97% of respondents regularly used from one to three techniques, while the rest regularly used more than three techniques. Details are shown in the Exhibit 5.

Options	Number of companies	Percentage
1	22	37%
1-2	30	51%
2-3	5	9%
More than 3 methods	2	3%
Blank	0	0
Total	59	100%

Respondents were asked to answer the question, has there been a major switch in techniques used over the last five years? Most of the companies have never change the methods they use over the last five years, while only 10 companies indicated that they tried to switch major techniques used. However, some managers provided some additional information in the end of the questionnaire. According to their demonstration, about three companies don’t want to use other techniques though they are popular and more appropriate to some extent. The reason could be some companies are not familiar with these methods and others do not believe that such methods could have a significant influence on their profits. They could change their methods according to their own experience and time management for projects could also result changing their capital budgeting method used. The results of the question are shown in Exhibit 6.

Options	Number of companies	Percentage
Yes	10	17%
No	49	83%
Blank	0	0
Total	59	100%

For a similar survey which was done by Meier (2001), he found that in his survey it showed that only 30 percent of the sample firms use capital budgeting techniques for all their investment decisions, while 50 percent of firms use evaluation methods for only some types of investment above a certain cost level. Specifically, 85 percent of the firms evaluate investment projects according to their budgetary cost restriction for a required investment amount of 1 million euros and above and only 5 percent of them for 10 million euros.

Another area of interest in our survey was to determine which techniques for assessing risk are currently used. All the respondents were asked to indicate the technique(s) used when assessing the risk of a major project. And the results are shown in Exhibit 7.

Options	Number of the companies	Rate
Sensitivity/Scenario analysis	41	70%
Raise the required rate of return	7	12%
Subjective assessment	2	3%
Probability analysis	5	8%
Shorten payback period	3	5 %
Beta analysis	0	0%
Ignore risk	0	0%
Other	1	2%
Total	59	100%

The results of the survey analysis show that seventy percent of the companies determine the risk of a project according to sensitivity or scenario analysis, while eight percent of them determine it according to the probability of losses and twelve percent according to the project’s the required rate of return. However, three executives also pointed out in the suggestion part that they would sometimes not incorporate risk analysis into their investment decisions if the use of such methods will not affect firm’s profits according to the enterprise’s volume of business. Some companies may lack staff and experience for this type of analysis. All of these could have influence of the risk analysis on investment projects of the companies.

Scenario analysis and sensitivity analyses were perceived to be the two most important techniques for assessing risk in China. The other more sophisticated techniques listed, beta analysis and shorten payback period, received significantly lower ratings, indicating that these techniques are seldom used in practice. Wong, Fairagher, and Leung (1987) had similar findings and conclusions based upon the frequency of use; sensitivity and scenario analysis were the techniques most frequently used by their respondents in Singapore, Hong Kong, and Malaysia. George, Chang, and Wang (1999) did a similar survey in 1990s. Though their surveyed countries were Hong Kong and some other Asian countries, the same question was included in their survey. And they also found that sensitivity and scenario analysis were the techniques most frequently used by their respondents while decision tree and probabilistic simulation were seldom used in practice.

Another question focused on the method used to determine the minimum acceptable rate of return (discount rate) on proposed capital investments. Finance theory suggests that different discount rates should be used for projects of different risk. The survey did not include questions about project risks. Therefore, to keep the structures of the questionnaire simple, the survey does not show the extent to which discount rates were tailored to project risk. Respondents were asked to indicate that how their companies derive the discount rate used in the appraisal of major capital investment. Among all the responses, 32 companies choose to use weighted average cost of capital to obtain their own discount rate for the analysis of the investment projects, which accounts for 54% of the total. Only 17 of the 59 companies prefer to use the cost of equity which was derived from the capital asset pricing model to do their analysis work and to determine the minimum acceptable rate of return. None of the companies reported using an arbitrarily chosen figure or dividend yield on shares plus estimated growth in capital value of share or earnings yield on shares. Six companies use the interest payable on debt capital but they also indicate that they just began to use it since last year. And one company uses another method to get the discount rate and three companies left it blank. It could be seen from the result of the survey that Chinese companies in small and medium business tend to use weighted average cost of capital to obtain their own discount rate for the analysis of the investment projects rather than some method they are not very familiar with, such as interest payable on debt capital and they will not choose to use an arbitrarily chosen figure, because it is risky and easy to get a wrong decision in the end. The reason that no one of the company use dividend yield on shares plus estimated growth in capital value of share or earnings yield on shares is difficult to find out but from the data collected it could be clearly know that the size of the sample companies are not large and few of them are listed companies. Therefore, it is not wise to use such kind of method to do analysis work. Furthermore, one manager indicated that lack of enough competent people who could understand the capital budgeting techniques and use dividend yield on shares plus estimated growth in capital value of share or earnings yield on shares to determine the minimum acceptable rate of return on proposed capital investments and then get the accurate result. They would like to use some simple method with popularity to analyze their project.

There are some similar surveys. Truong, Partington & Peat (2008) did a survey in 2008. They examine how the discount rate was selected for individual projects, how many years ahead the companies made forecasts, how they estimated terminal values, and whether they adjusted the discount rate over the forecast period. After they surveyed about 356 companies in Australia, they indicated that the majority of companies (57%) used the company’s discount rate in project evaluation, the second most popular alternative (22%) was the cost of debt plus a risk premium, and a number of respondents (17%) relied on previous experience. Different discount rates for different divisions were reported by 16% of companies and 13% of companies reported that they would use the divisional discount rate for individual projects.

Finance textbooks usually describe three methods to estimate a company’s cost of equity capital. These include: 1) the CAPM, based upon the company’s beta, 2) the dividend yield plus expected growth rate method (based upon the constant growth dividend valuation model), and 3) the risk premium method (cost of debt plus risk premium) (Zhang Suyun, 2007). In order to know the methods of estimating the cost of equity capital, respondents were firstly asked about whether their companies use cost of capital in the evaluation technique. And 41 of 59 companies indicated that they use cost of capital in the evaluation technique, while 18 of 59 companies chose no. And then the 41 companies which chose yes were asked to indicate the source of cost of capital estimate. About 20 companies chose to self-estimate and 1 company use both self-estimate and obtained from another source, while other 20 companies chose B option which means that the source of cost of capital estimate was obtained from another source. It accounted for about 50% of the total. The managers who chose the self-estimate option indicated that though there could be some errors when estimating, they could always adjust the relative factor according to the reality and operation of their own companies and the recent financial environment.

And then managers were asked about which method their companies used. As to the question which of the following methods does your firm use to estimate the cost of capital, most companies chose to use the capital asset pricing module. And it accounted for 70% of the total. For another thing, six companies indicated that they would like to use cost of debt plus risk premium and none of them chose dividend yield plus growth rate as their analysis method. The reason for this could be that most of them are not listed companies and the dividend yield plus growth rate is difficult to understand and hard to use though it could be more accurate than other methods. However, some of the accountant of the companies indicated that they should also think about the time and cost. If the investment project is small and there is limited time, they will prefer to use the capital asset pricing module. Because they think growth rate is difficult to calculate. It need people who have good professional skills to obtain the companies’ growth rates.

The next question was: Does your company estimate the weighted average cost of capital (WACC)? Since all the forty-one respondents answered yes, they were asked to answer the continuing question: If the WACC is used, then the weights are defined by which option? The results are shown in Exhibit 8.

Options	Number of companies	Rates
A long term target of debt and equity ratio	10	24%
The present market values of debt and equity	16	39%
Balance sheet ratios of debt and equity	15	37%
Total	41	100%

According to the results of the survey, it is apparent that about 10 companies thought that the weights are defined by a long term target of debt and equity ratio, while sixteen companies chose B option which refers to the present market values of debt and equity. And fifteen companies defined weights by the balance sheet ratios of debt and equity. The respondents were asked to specify the method of calculating the WACC. The results are shown in Exhibit 9.

Options	Number of companies	Rates
Use the capital asset pricing model for equity and market rate of return on debt capital	30	75%
Cost of equity calculated other than through the capital asset pricing model with the cost of debt derived from current market interest rates	5	13%
Other	3	7%
Blank	2	5%
Total	40	100%

From the table above, it could be clearly seen that most of the companies use the capital asset pricing model for equity and market rate of return on debt capital for calculating the WACC. The percentage arrived 75% of the total, which is much higher than other two options. And five companies tried to use cost of equity calculated other than through the capital asset pricing model with the cost of debt derived from current market interest rates, while three companies use other methods to calculate the WACC and two companies left blank.

As to the cost of capital part, it is difficult to find out why each company chose their own method instead of others and it did not elicit the principal reasons for cost of capital calculating by those companies that do practice capital analysis in this survey. However, there are two companies’ manager and accountants who express their opinions on the suggestion part at the end of the questionnaire. These could provide some useful information. They pointed out that all the methods they chose and used depended on the financial situation and operation of the whole company. Sometimes if they believed that determining the cost of capital will not affect their profit or there is limited time and staff, the firm will not use any formal approach to determine their cost of capital.

The Chinese practice in estimating the cost of capital revealed in the current survey is similar to the findings of Kester et al. (1999) as well as overseas practice in that the capital assets pricing model is found to be the most popular method used in the estimation of the cost of equity capital. It is also noticeable that similar survey conducted by Ioannis (2004) has similar results. He found that most of the sample firms (31 percent) determine their cost of capital according to the cost of borrowing, while 26 percent of them depend on their past experience. Of the firms surveyed, 20 percent determine their cost of capital according to the cost of equity capital, and only 6 percent use the weighted average cost of capital. Another survey was conducted by Graham and Harvey (2001). They found that the capital assets pricing model was the most popular method of estimating the cost of equity, with 73% of respondents relying mainly on the capital assets pricing model. It appears that the use of the capital assets pricing model has grown substantially over time.

Respondents were asked about whether estimated cash flows (or earnings) of proposed capital investments were evaluated before or after income taxes. Although the majority of respondents that indicated that cash flows are evaluated after taxes, there are still a few respondents indicated that cash flows (or earnings) were evaluated before taxes. The results are shown in Exhibit 10.

Options	Number of the companies	Percentage
Before tax	8	20%
After tax	31	75%
Blank	2	5%
Total	41	100%

In this part, in order to determine whether the sample of companies engage in capital rationing, respondents were asked to indicate "yes or no" to the question, "Does your company place a limit on the size of its annual capital budget?" and they should also answer the question about how many years ahead the capital expenditure budgets are prepared for. The results are shown in Exhibits 11 and 12.Theory tells us that a company should expand (accept investment projects) to the point where its marginal return is just equal to its marginal cost. It means that capital rationing implies an arbitrary limit is placed on the amount of funds that can be invested within a given time period. However, some companies ration capital which means that placing an absolute limit on the size of their capital budgets. The principal reason for capital rationing is that some companies are reluctant to obtain external financing (Graham & Harvey 2001). A limit may be placed upon the companies’ borrowing by internal management or external lending institutions.

Options	Number of companies	Percentage
Yes	28	48%
No	30	51%
Blank	1	2%
Total	59	100%

The results indicated that managers and accountants of small and medium sized Chinese companies are much more likely to dictate the amount of funds that could be spent and determine if there are projects worthy of taking. About thirty managers of the respondent companies indicated that their companies do not practice capital rationing. One manager chose not to leave it blank. It is not possible to elicit the principal reasons for capital rationing by those companies that do practice capital rationing.

Options	Number of companies	Percentage
1 year ahead	8	14%
2 year ahead	13	22%
3 year ahead	16	27%
4 year ahead	12	20%
More than 4 years ahead	8	13%
Blank	2	4%
Total	59	100%

For the question how many years the capital expenditure budgets are prepared for in the companies, different companies gave different answers. From the results shown in Exhibit 12, it could be conclude that most of the companies tend to prepare their capital expenditure budgets in a short term instead of a long term. Twenty-one managers chose to prepare their capital expenditure budgets in less than two years’ time, which accounts for 36% of all the fifty-nine firms. Sixteen managers chose three years ahead and twelve managers chose four years ahead, which accounts for 27% and 20% respectively. Only eight managers prepare their capital expenditure budgets more than four years ahead. The reason for this result could be that managers consider their capital expenditure budgets in relation to the profit of their companies.

As to minimum size of projects that require quantitative analysis, respondents were asked to indicate the project size that requires a formal quantitative analysis in their companies. According to the responds of the questionnaires, the median project sizes requiring a formal quantitative analysis was about RMB￥ 1,000,000 in China which is equal to 100,000 pounds. Two managers indicated in their suggestion part that their companies require a quantitative analysis on all proposed investments, regardless of size.

And the respondents were also asked about how much money their companies spend every year on capital budget. The results are shown in Exhibit 13.

Options	Number of companies	Percentage
Up to 0.1 million RMB	4	7%
0.1 million to 0.5 million	9	15%
0.5 million to 1 million	21	35%
1 million to 10 million	19	32%
10 million to 50 million	4	7%
More than 50 million	1	2%
Blank	1	2%
Total	59	100%

For the last question, does your company conduct post-audits of major capital expenditure? The results are shown in Exhibit 14. The majority of managers chose to conduct post-audits of major capital expenditure sometimes or rarely, which accounts for more than 80% of the total. And only five companies always conduct post-audits of major capital expenditure. It could be seen that most of the companies do not pay much attention to post-audits. Only a small part of companies always conduct post-audits every year.

Options	Number of companies	Percentage
Always	5	9%
Sometimes	34	57%
Rarely	16	27%
Never	4	7%
Total	59	100%

Generally, from the data collected in this survey, a trend of using capital budgeting techniques in small and medium sized Chinese business could be described. The managers in these firms tend to use payback method with net present value method for project evaluation, though these methods ignored the time value. The reason is that their companies have limited fund and resources. Lack of staff, time, and experience could be important factors for the companies to choose their capital budgeting techniques when making investment decisions. Investment return period should also be considered when making investment decisions. When large amounts of funds are raised, firms must pay close attention to the financial markets because the cost of capital is directly related to the current interest rate. The need for relevant information and analysis of capital budgeting alternatives has inspired the evolution of a series of models to assist firms in making the best allocation of resources. Based on the analysis in the section, there are conclusions made in the next section.

The survey has focused on a number of issues that have not been adequately covered by previous surveys. The questionnaire responses suggest the following profile for a typical respondent company. Investment projects are usually evaluated using net present value, but the company is likely to also use other techniques such as internal rate of return and payback methods.

It is noticeable for the results that approximately 80% of respondent companies prefer to use the payback method which has a serious flaw. Payback method ignores the time value of money, though it is easy to use and simple to calculate and understand. The payback method measures the length of time it takes to recover the initial investment and ignores cash flows beyond the recovery period. One reason for the popularity of the payback period is that it focuses on short-term profitability. Managers who use the payback can readily identify projects that have the earliest prospect of profitability. For another thing, some small and medium sized firms cannot obtain bank loans because of their information-opaqueness and lack of strong banking relationships. These capital constraints can make it essential for small firms to maintain sufficient cash balances in order to respond to potentially profitable investments as they become available (Almeida, Campello, and Weisbach, 2004). Because of these capital constraints small privately held firms would pay much attention to how quickly a project will generate cash flows (i.e., the payback period). The CAPM remains the pre-eminent asset pricing model in practice, despite academic criticism and the development of alternative multifactor asset pricing models. There is another issue about the application of the time-varying risk concept in practice. Though some acknowledge the risk of ignorance of time value, they apply a fixed discount rate in their evaluation techniques. It is difficult to find out the reason of this issue, but some companies indicated that it is not easy to forecast time variation reliably in discount rates.

It could be concluded that the project cash flows are discounted at the weighted average cost of capital as computed by the company, and most companies use the same discount rate. The discount rate is assumed constant for the life of the project. The WACC is based on target weights for debt and equity. The capital assets pricing model is used in estimating the cost of equity capital, with the treasury-bond rate used as a proxy for the risk-free rate, beta estimates are obtained from public sources. Asset pricing models other than the capital assets pricing model are not used in estimating the cost of capital. The cost of debt is adjusted to allow for the effect of interest tax shields, but not by a significant minority of companies. The discount rate is reviewed regularly to some extent, at least annually, and the inputs used in the calculation will be varied over time. The main reasons for not making an adjustment are the difficulty of the task, or the belief that the value effect is small.

Since the small and medium sized firms’ acceptable return on investment should be above the return on risk free investment in the market, the analytical technique of discounted cash flow method could reflect the risk element of investment projects. Large companies mainly choose the discounted cash flow method and internal rate of return method as their major analytical methods. While small and medium companies which has limited value and capital and financial analysts, it may be not possible for them to use the appropriate capital budgeting techniques for making investment decisions. Therefore, based on the constraints on the operations of some companies in China, it is essential to improve the current financing and operating situation of small and medium sized firms. In order to resolve the short investment period of small and medium sized firms, there are several methods which could be used, for example, organizing and conducing trainings to staff or managers of companies, improving the financial analytical skills and financial forecasting so that the decision-making skills for capital budgeting could be enhanced. At the some time, it is also significant to pay attention to the situations out the company which includes the economic developments of the industry and the information of their competitors, and try to improve the financing situation, broaden financing channels and decrease the unnecessary financial burden when making capital budgeting. The good development of small and medium firms could not only create more investment opportunities, but also be a good way to employ more competent people. In that case, it would create a positive circle for the companies.

Like other studies of this kind, this survey has limitations. Firstly, the survey was limited to the small and medium companies in China. Secondly, the capital budgeting practices of small and medium companies is not likely to be representative of all companies in the surveyed countries, because there are approximately 42,300,000 small and medium firms in China in the end of 2006 according to the data provided by national bureau of statistic of China. Furthermore, as pointed out by Aggarwal (1980), responses to questionnaires by individuals in the companies do not always reflect the practices used throughout the company. There is no guarantee that the respondents reflect the target sample. But they are used as an accurate indicator of each company’s practices. Confidence in this matter is enhanced by the seniority and nature of the positions occupied by respondents. Restricting the length of the questionnaire in order to improve the response rate means that some issues were not investigated in detail. Nevertheless, sample surveys, such as this one, have the benefit of updating our knowledge of practice, identifying gaps between theory and practice, and suggesting areas for future research.

The survey questionnaires used in this study were inherently limited in scope, based upon Western models of corporate financial policy, which are, in turn, based upon stringent underlying assumptions about market conditions and company behavior. Such an approach implies a level of universality that may not exist. Further research is needed to discover whether cultural and institutional issues are significantly related to capital budgeting practices that are unique to the countries of the Asia-Pacific region.

There may also be non-response bias in the results. The response rates were low, and the results may largely reflect the responses of executives familiar with Western models and techniques. However, it is not possible to determine from the survey results if such a source of non-response bias exists.

Techniques

Not applicable

Unimportant

Moderately important

Very important

Indispensable