Capital Budgeting Decisions

How Do CFOs Make Capital Budgeting and Capital Structure Decisions?

The purpose of this article was ton investigate and discuss decisions related to budgeting capital, and how finance executives can use the correlation between corporate practice and financial theory to make the best decisions possible. Furthermore, these decisions and observations can be used to see how other companies use this information and make decisions for their companies, letting executives potentially see the affects, good or bad, of certain decisions made. The surveys used to collect the data and draw conclusions looked at many aspects of the company, such as its market capitalization, P/E ratio, leverage, credit rating, etc.

Survey results showed that most companies do follow academic theory and used discount cash flow analysis, as well as net present value to aid in their decisions with respect to capital budgeting. On the contrary, with respect to capital structure decisions, CFOs tend to not follow financial theory and instead use logical and rules of thumb. While in financial theory it is taught that reducing WACC is an intelligent objective, financial professionals are instead choosing to focus more on preserving “financial flexibility” to aid in keeping a given credit rating. CFOs were also more hesitant to issue common equity, which is taught to be a safer form of raising capital given that there is no obligatory pay back, or interest payments that need to be paid. This is done in an effort not to dilute EPS which may have a negative impact on the firm’s share price. The survey information also found that larger companies chose to use the NPV rule more, while smaller companies focused on payback criterion.

A fundamental rule of capital budgeting decision making is that the value of the firm is equal to the discounted expected future cash flows. Therefore, if the NPV of a project is greater than zero, it should be accepted. Survey data has shown in the past that more...