Capital budgeting in Europe: confronting theory with practice

This research presents an analysis of capital budgeting in three different countries: Italy, France and Spain. The results revealed that PP, followed by net present value, is the most used method, but there is a difference between large and small firms. This research has demonstrated that capital budgeting decision-making is a complex process and that it is undervalued by SMEs.

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Capital budgeting in Europe: Confronting theory with practice
Article in International Journal of Managerial and Financial Accounting · January 2014
DOI: 10.1504/IJMFA.2014.066403
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Int. J. Managerial and Financial Accounting, Vol. 6, No. 4, 2014 341
Copyright © 2014 Inderscience Enterprises Ltd.
Capital budgeting in Europe: confronting theory
with practice
Matteo Rossi
DEMM Department,
University of Sannio,
Via delle Puglie, 82, 82100 Benevento, Italy
Email: [e-mail]
Abstract: Capital budgeting is an important area of financial management. It is
a process used to determine whether firm’s long-term investments are worth
the funding of cash through the firm’s capitalisation structure. Different
techniques are used: the payback period, the accounting rate of return, the
present value and the internal rate of return and the profitability index. This
research presents an analysis of capital budgeting in three different countries:
Italy, France and Spain. The results revealed that PP, followed by net present
value, is the most used method, but there is a difference between large and
small firms. This research has demonstrated that capital budgeting decision-
making is a complex process and that it is undervalued by SMEs. The
limitations of the paper are the result of its very nature: it is a largely
conceptual paper.
Keywords: capital budgeting; NPV; net present value; IRR; internal rate of
return; payback period; WAAC.
Reference to this paper should be made as follows: Rossi, M. (2014) ‘Capital
budgeting in Europe: confronting theory with practice’, Int. J. Managerial and
Financial Accounting, Vol. 6, No. 4, pp.341–356.
Biographical notes: Matteo Rossi is an Assistant Professor of Corporate
Finance at the University of Sannio, Italy. He holds a PhD in Corporate
Governance and his prime research interests are corporate finance, financing
innovation and finance for SMEs. He is Vice President of the EuroMed
Research Business Institute. He is an Associate Editor of Global Business and
Economics, International Journal of Bond and Derivatives and International
Journal of Managerial and Financial Accounting. In 2014, he won the highly
commended paper award of the International Journal of Organizational
Analysis (Emerald) for the paper ‘Mergers and acquisitions in the high-tech
industry: a literature review’.
1 Introduction
Capital budgeting has a fundamental role in any firm’s financial management strategy.
Capital budgeting is the “process of evaluating and selecting long-term investments that
are consistent with the business’s goal of maximising owner wealth” (Gitman, 2008,
p.380).

342 M. Rossi
These decisions require that a firm defines all of the necessary steps to ensure that its
decision-making criteria support the business’s strategy: “the realisation that a business
leverages its competitive advantage on its resources and on how it undertakes decisions
relating to the use of its resources, such as financial resources call for managers to make
informed decisions” (Brijlal and Llorente Quesada, 2008). Today, it is necessary – in a
highly competitive environment – to make each decision after acquiring information.
This paper is based on a survey of managers of firms in three different countries of EU
on how they undertook capital budgeting practices. The research follows similar surveys
conducted around the globe such as those by Kester et al. (1999), Kester and Chong
(2001), Sandahl and Sjogren (2003), Brijlal and Llorente Quesada (2008), Bennouna
et al. (2010) and Hartwig (2012).
The paper is organised as follows: Section 2 presents a literature review on capital
budgeting techniques. Subsequently, Section 3 presents the research methodology and
objectives. Section 4 presents the main results of our research. Section 5 presents some
managerial implications, and finally, Section 6 draws conclusions from the research
findings and investigates future directions.
2 Literature review
Many scholars (Arya et al., 1998; Swain and Haka, 2000; Brijlal and Llorente Quesada,
2008) maintain that capital budgeting decisions are crucial to a business’s performance.
In fact, capital budgeting plays a vital role in a business’s competitive model. Kwak et al.
(1996) thus state that capital budgeting is not a banal decision. A business whose ability
to effectively develop a possible mechanism for capital budgeting may realise a better
competitive advantage over its rivals in an environment that is characterised by change
and volatility (Lazaridis, 2004).
Many studies have been conducted worldwide that provide interesting results on
capital budgeting practices (Jog and Srivastava, 1995; Pike, 1996; Drury and Tayles,
1996; Block, 1997; Kester et al., 1999; Graham and Harvey, 2001; Sandahl and Sjogren,
2003; Brounen et al., 2004; Lazaridis, 2004; Hermes et al., 2007; Truong et al., 2008;
Bennouna et al., 2010; Andor et al., 2012). The major international research is
concentrated on capital budgeting practices in large firms. Only few research has
considered small and medium enterprises (Rossi, 2014). Managers use different
techniques to facilitate capital budgeting procedures. In practice, capital budgeting differs
from industry to industry and from country to country. The first important conclusion is
that in managerial decision-making, theory seems to be ignored in practice.
Important studies on capital budgeting were conducted by Drury and Tayles (1996),
Maccarrone (1996), Kester et al. (1999), Sandahl and Sjogren (2003), Lazaridis (2004),
Hermes et al. (2007) and Rossi (2014). These studies focus on different countries such as
Italy, Cyprus, the Netherlands, China, Singapore, other Asiatic countries, Sweden,
Canada, the USA, and the UK. These surveys have shown that the sophistication of the
analytical techniques used by executives has increased over time. But, literature on
capital budgeting techniques presents a high fragmentation. Kester et al. (1999) affirm
that Discounted Cash Flow (DCF) techniques – such as Net Present Value (NPV) and
Internal Rate of Return (IRR) – have become the dominant methods of evaluating capital

Capital budgeting in Europe 343
investment. Rossi (2014) shows that PP, followed by NPV, is the most used method, but
there is a difference between large and small firms. In fact, the more complex methods
are most favoured by the larger enterprises.
Concerning the result of capital budgeting decisions on a firm’s performance, an
important contribution comes from the study of Hatfield et al. (1998). They investigate
the importance of PP, ARR, IRR and NPV capital budgeting techniques on the
performance and value measures of firms. Hatfield et al. (1998) stressed that enterprises
that analysed each project had a higher share price on an average compared to those that
did not. A second result of their study was that the NPV technique did not maximise the
value of the business. Their results suggest that firms should not only use one capital
budgeting technique but also apply at least two or three methods when evaluating a
project.
Block (1997) focuses on the capital budgeting techniques used by small firms. He
examines a sample of 232 small businesses. Research reveals that the payback method is
still the preferred approach in 42.7% of the firms. Unlike many larger firms, these firms’
time horizon is often the period over which a financial institution will extend them
funding.
Graham and Harvey (2001) survey 392 CFOs about the cost of capital, capital
budgeting and capital structure. The results disclose that “large firms rely heavily on
present value techniques and the capital asset pricing model, while small firms are
relatively likely to use the payback criterion” (Graham and Harvey, 2001, p.187). The
authors find that IRR and NPV were the most frequently used capital budgeting
techniques. Other techniques such as the payback period were less popular but were still
used by many companies.
Brounen et al. (2004) conducted a survey of 313 CFOs across four European
countries (the UK, the Netherlands, Germany and France) on capital budgeting, cost of
capital, capital structure and corporate governance. Their results indicate that “while
large firms frequently use present value techniques and the capital asset pricing model
when assessing the financial feasibility of an investment opportunity, CFOs of small
firms still rely on the payback criterion” (Brounen et al., 2004, p.71).
More recently, Truong et al. (2008) perform an important study on capital budgeting
in Australia. They use a sample survey to analyse the capital-budgeting practices of
356 Australian-listed companies and find that NPV, IRR and payback are the most
popular evaluation techniques.
Bennouna et al. (2010) focus on the capital budgeting decision-making of Canadian
firms, including 88 large firms. The results show that the trends towards sophisticated
techniques have continued; however, even in large firms, 17% did not use DCF. Of those
that did use DCF, the majority favoured NPV and IRR.
Hartwig (2012) conducts a similar study, analysing the use of capital budgeting and
cost of capital estimation methods in Swedish-listed companies to study the relationship
between characteristics of the company and their choice of methods, making both
within-country longitudinal and cross-country comparisons. The results reveal that larger
companies seem to use capital budgeting methods more frequently than smaller
companies. Compared to US and continental European companies, Swedish-listed
companies employed capital budgeting methods less frequently.

344 M. Rossi
Andor et al. (2012) perform another important study on capital budgeting techniques
in European countries. They conduct a survey of 400 executives in ten countries in
Central and Eastern Europe (CEE) – Bulgaria, Croatia, Czech Republic, Hungary, Latvia,
Lithuania, Poland, Romania, Slovak Republic and Slovenia. They find that the capital
budgeting practices in CEE countries are influenced most by firm’s size, multinational
culture, firms’ goals, code of ethics and, to a lesser extent, executive ownership, number
of projects analysed, and target leverage.
The last important research conducted on 71 Italian firms by Rossi (2014) shows that
PP, followed by NPV, is the most used method, but there is a difference between large
and small firms. This research shows that the more complex methods are most favoured
by the larger enterprises. The principal weakness of the evaluation process is the
definition of cost of capital. In fact, approximately 70% of the enterprises considered use
non-quantitative techniques to consider risk when deciding whether to invest in fixed
assets.
Starting from the work of Rossi (2014) and Brounen et al. (2004), this research
presents a description of capital budgeting practices in three different European
countries: Italy, France and Spain. The principal motivation of this study is the small
amount of empirical research on capital budgeting practices in different countries of EU
compared to other regions of different countries such as the USA, the UK, Canada, China
and Singapore. Through this research, additional empirical evidence relating to capital
budgeting practices in Southern Europe was sought.
3 Research methods
The research sought to gather both quantitative and qualitative data related to capital
budgeting practices in three European countries: Italy, France and Spain. Data were
obtained through a survey of business firms. The research subjects were CFOs who
were responsible for capital budgeting decisions. To achieve this goal, a total of 110
entrepreneurs-managers from different types of firms were targeted as potential
respondents. This sample has been extracted from the Bureau van Dijk databases that
contain economic and financial information. The respondents were selected randomly
from the small, medium and large businesses listed in these databases. Owing to the
nature of capital budgeting practices, the research focused primarily on the CFOs and
managers who were involved in capital budgeting decisions.
A pilot test of the survey interview schedule was presented in a previous research
(Rossi, 2014). The purpose of pilot testing was to check the relevance of the questions
before interviewing. A descriptive approach to the research finding was adopted. This
was augmented by the Chi-squared test, which was used to measure the association
between variables. Quantitative analysis of the data obtained was carried out using the
SPSS software. The qualitative issues raised during the research are incorporated to
explain the associations and other relationships that were suggested by the research
findings. Of the 110-targeted interviews, 43 interviews were successfully conducted,
giving a response rate of approximately 39% (Figure 1).

Capital budgeting in Europe 345
Figure 1 Participation in the survey (see online version for colours)
Source: Author’s calculation
The first important result is that 41 firms declared that they do not use capital budgeting
techniques (Figure 2).
Figure 2 Participation in the survey (see online version for colours)
Source: Author’s calculation
4 Main results
The following section discusses the main findings and results of the survey on the capital
budgeting techniques used by 43 European firms.
The first classification considers the business size and sector of the firms involved.
From a total of 43 respondents, 25% qualified as large firms, while 75% were SMEs. The
respondents were further categorised according to industry. Of the firms in the survey,
53.49% represented the service sector, 18.60% were in retail, and the remaining 27.91%
were involved in manufacturing activities.

346 M. Rossi
4.1 Capital budgeting techniques employed
Scholars distinguish between two DCF techniques: traditional and modern. Managers
can use either of these techniques. Capital budgeting theory favours the use of DCF
techniques based on the time value of money. Managers make capital budgeting
decisions based on the assumption that the primary goal of the business is to maximise
the shareholders’ wealth (Brealey et al., 2011). If this consideration is true, firms will
invest in projects that will yield a positive NPV. Some important research supports this
point of view. Graham and Harvey (2001) and others explain why DCF techniques have
become a dominant technique for evaluating capital budgeting decisions, particularly in
large and more structured enterprises. However, Graham and Harvey (2001) and Rossi
(2014) in their research conclude that due to limited managerial skills, less complicated
techniques such as the payback method continue to dominate capital budgeting decision-
making. Starting from a previous research (Rossi, 2014), the survey covered the use of all
different techniques, including both capital budgeting discounted and non-discounted
capital budgeting methods. Results are shown in Table 1.
Table 1 Capital budgeting techniques used by firms
Method IRR NPV PI PP ARR
Number of firm 7 11 5 16 4
Source: Author’s calculation
The results suggest that the PP technique was the most frequently used method to
evaluate capital budgeting decisions (37.21% of respondents). This was followed by the
NPV method (25.58%), IRR (16.28%), profitability index (11.63%), and accounting rate
of return (9.30%).
A first consideration concerns the large use of PP and IRR. This result shows that a
huge number of firms (about 54%) have a short-term vision. In fact, the IRR is more of a
short-term measure and is used as an approach to assess the rate that would be used to
make the present value of a project equal to the amount invested. For this reason, some
argue that it is a form of a payback method that uses a rate.
It is necessary to remember that many of the CFOs-entrepreneurs indicated that they
did not use any techniques. In their evaluations, they used only their intuition. The
payback period method was the most popular among SMEs, while the larger firms used
the NPV technique.
There are not significant differences between countries (Table 2).
Table 2 Capital budgeting techniques used by firms, by countries
Method IRR NPV PI PP ARR
Italy 4 5 2 9 1
France 2 4 0 2 1
Spain 1 2 0 4 1
Source: Author’s calculation
The main difference is the use of NPV: French firms prefer this technique. Italian and
Spanish firms show the similar results. This simple result shows that the French sample is
characterised for the presence of qualified financial staff.

Capital budgeting in Europe 347
4.2 Capital budgeting techniques used by sector
The research findings show that the PP is more likely to be used by firms in the
manufacturing sector, while firms in the services sector prefer the IRR. The NPV method
seemed to be used to the same extent by firms in both retail and service sectors. The
ARR seemed to be the least used technique across all business sectors (Table 3).
Table 3 shows the usage percentage of the different methods by business sector.
Table 3 Capital budgeting method by sector usage
Technique Manufacturing (%) Retail (%) Service (%)
IRR 21 26 32
NPV 26 39 39
PI 18 30 33
PP 46 35 37
ARR 19 19 27
Source: Author’s calculation
In general, based on the Chi-squared test analysis, there seemed to be no association
between the size of the business and the use of the different capital budgeting techniques.
The research established that 72% of the firms surveyed used only one technique,
whereas 28% of the respondents used at least two different techniques.
The sample shows some differences between different types of techniques in different
countries. Italian manufacturing and service firms prefer the use of PP and IRR
techniques. Similar results show the Spanish sample: manufacturing and service firms
prefer IRR and PP, only manufacturing Spanish firms prefer NPV. The French sample is
characterised for the major number of firms that use NPV. Without any difference
between sectors, French firms prefer the NPV technique. As a second technique, the
manufacturing French firms prefer IRR, instead retail and service firms prefer, as
additional technique, PP.
4.3 Capital budgeting techniques used by size
Another important step of this research is to analyse the responses given per size
category of firms and the method(s) used for capital budgeting (Table 4).
Table 4 Business category and capital budgeting technique used
Technique Small (%) Medium (%) Large (%)
IRR 22 13 37
NPV 27 37 44
PI 30 19 32
PP 42 35 37
ARR 14 23 26
Source: Author’s calculation

348 M. Rossi
These results confirm the theory that as the size of the firm increases, so does the use
of more complicated techniques. This research shows that smaller firms use the PP
technique more than the NPV and IRR, which are used more by larger enterprises.
The Chi-squared tests showed that there was an association between a firm’s size and
its use of the IRR and NPV methods (p < 0.05). The results show that the more
complicated techniques (IRR and NPV) are favoured most by the medium and large
enterprises. Furthermore, the results showed that there was no association between the
firm’s size and the use of other techniques (PP and ARR). There is an inverse
relationship between size and not using capital budgeting techniques. In fact, the research
findings show that size does affect the use of capital budgeting methods.
In particular, the results show the following:
1 The PP method was equally used across enterprises of all sizes, and
2 The smaller the size of a business, the less likely the business is to use capital
budgeting techniques (p < 0.05).
4.4 Sector of business and the most important stage in capital budgeting
Capital budgeting techniques are complex processes based on different steps. Gitman
(2008) defines five different steps: proposal generation, review and analysis, decision-
making, implementation and follow-up.
In this study, capital budgeting decisions were categorised into four steps (Rossi,
2014):
 project definition
 analysis and selection
 implementation, and
 review.
Each of these stages has a huge importance, but managers-entrepreneurs give a different
weight to each stage. To verify the importance attached to each stage in the capital
budgeting process, the respondents were asked to rate each of the four stages in order of
importance on a scale of 1–4 (with 4 being most important). Table 5 summarises the
responses.
Table 5 Importance of a capital budgeting step
Stages in Capital
Budgeting
Project
Definition
Analysis and
Selection Implementation Review
% 51 33 10 6
Source: Author’s calculation
According to these results, 51% of the managers-entrepreneurs believed that project
definition was the most important stage. The analysis and selection stage was deemed
important by 33% of the respondents, and 10% of the respondents thought that the
implementation stage was the most important, while 3% considered review important.
These results demonstrate that a large number of firms have short-term vision. In fact,
84% of firms sustain the relevance of first two stages. The implantation and review steps
are not considered important phases of capital budgeting process.

Capital budgeting in Europe 349
There are some differences between the countries (Figure 3). Indeed, French firms
present the maximum equilibrium between different stages: project definition, 35%;
analysis and selection, 28%; implementation, 22%; and review, 15%. These results
underline the presence of qualified financial staff in the French sample.
Figure 3 Importance of a capital budgeting step, by countries (see online version for colours)
Source: Author’s calculation
There is no difference between the sectors and firms’ sizes: the project definition stage is
considered the most important stage in the capital budgeting process. Furthermore, the
research has identified the difficulties that managers recognise in each of the stages of
capital budgeting. Table 6 shows the results of each of the respondents when asked to
rate each of the four stages in order of difficulty on a scale of 1–4 (with 4 being most
difficult).
Table 6 Level of difficulty in the capital budgeting stage
Stages in Capital
Budgeting
Project
Definition
Analysis and
Selection
Implementation Review
% 33 31 26 10
Source: Author’s calculation
The analysis of the level of difficulty was pursued further in the different business sectors
to determine whether all of the sectors felt the same about the most difficult stage in
capital budgeting. Table 7 shows the most difficult step in the capital budgeting process
by sector.
Table 7 Level of difficulty and sector
Stages in Capital
Budgeting
Project
Definition
Analysis and
Selection Implementation Review
Manufacturing 22 24 36 18
Retail 30 30 31 9
Service 38 31 24 7
Source: Author’s calculation

350 M. Rossi
The implementation stage appeared to be the most difficult stage for the manufacturing
sector. Project definition, analysis and selection, and implementation were rated as
difficult steps by firms in the retail sector. Project definition and analysis and selection
were found to be the most difficult stages by the service sector. An analysis of firm’s size
shows that project definition was the most difficult stage for small businesses;
implementation was the most difficult step for medium enterprises; and analysis and
selection was the most difficult stage for the large firms. A possible reason for these
results could be a lack of skills, but it could require deeper analysis in a future study.
The analysis for different countries shows different results: project definition was
found to be the most difficult step for the Spanish and Italian firms. Implementation was
the most difficult stage for French firms. A possible reason for these results could be the
bigger size and the presence of qualified financial staff in French firms.
One of the results of this analysis is the need for managers to review their perception
of the importance of each step in the decision-making process. Doing so may assist them
in identifying deficiencies in the methods or in the whole capital budgeting process itself.
Such a realisation will help firms make a good decision. The fact that the review process
is not considered important for all firms (classified for size, for country or for sector)
highlights that managers-entrepreneurs continue to follow the same capital budgeting
scheme. They have difficult to consider any comments from the review process. This
approach may have a negative impact on the firm’s financial management policy,
because they do not change their previous processes.
4.5 The definition of interest rate used in capital budgeting
Capital budgeting decisions are based on interest rates. In fact, interest rates play a
fundamental role in these complex decisions. In this study, 27.91% of the respondents
used the cost of a bank loan 1 as a basis, while 16.28% used Weighted Average Cost of
Capital (WACC) and 20.93% used past experience as a basis for determining the cost of
capital (Figure 4).
Figure 4 Interest rate used for capital budgeting (see online version for colours)
Source: Author’s calculation
These results showed that there was no association between the following:
 the size of the business and the interest rate charged, and
 the sector of the business and the interest rate charged.

Capital budgeting in Europe 351
The research results indicate that approximately 55% of managers-entrepreneurs used
non-quantitative techniques to consider risk when deciding whether to invest in fixed
assets. In terms of the business sector and the use of non-quantitative techniques, 49% of
the manufacturing firms surveyed used these techniques, as did 41% of the retail sector
firms and 63% of the service sector firms.
Approximately 45% of the managers used quantitative techniques to consider risk.
There was no significant difference between the different sectors and the quantitative
techniques used. However, the research findings indicated that firms involved in retail
were less likely to use quantitative techniques compared to those firms involved in
manufacturing and service.
An analysis for the countries shows there are little differences between France, Spain
and Italy (Figure 5).
Figure 5 Interest rate used for capital budgeting for country (see online version for colours)
Source: Author’s calculation
Italian firms prefer to use cost of bank loan: about 33% use the interest rate of their loan,
a little part use WACC (about 14%). Spanish firms prefer the interest rate of past
experience (46%). For these firms the use of WACC is marginal (about 8%). French
firms use in similar way cost of bank loan and WACC (about 45% both methods). This
result shows the heterogeneity of techniques in different countries. The French result is
the signal of the presence of qualified financial.
4.6 Capital budgeting decision makers
In capital budgeting decisions, the decision maker is very important. Different firms use
different decision makers to make capital budgeting decisions. Table 8 shows the
decision makers who were responsible for making capital budgeting decisions in terms of
the size of the business.

352 M. Rossi
Table 8 Capital budgeting decision makers
Decision Makers Small (%) Medium (%) Large (%)
Owner 80 59 19
Chief Financial Officer 3 13 44
Team Decision 17 28 37
Source: Author’s calculation
These results show that at about 60% of business owners are directly responsible for
capital budgeting decisions. Furthermore, the results suggest that different business-level
managers have limited influence on capital budgeting decision-making. However, their
influence expands with an increase in the business’s size. It would seem that businesses
that have a finance section allow their finance sections to have a significant influence in
all decision-making scenarios.
A similar view can be expressed in regard to the role played by teams in capital
budgeting. A possible explanation is linked to the nature of small businesses. The
majority of the interviewees in the small firms had limited operational structures, unlike
those in larger corporations. This may be why owners defined capital budgeting decision-
making in small firms. However, the same reason cannot be attributed to larger
enterprises, which have more formalised structures and larger work forces.
In comparison, some differences emerge between firms of different countries. In the
Italian and Spanish firms, about 70% of business owners are directly responsible for
these decisions. A possible motivation is the smaller dimension of firms of sample.
The French firms are characterised for the higher percentage of team decision in capital
budgeting choices (about 40%).
5 Managerial implications
A theory-practice gap remains in the DCF application among firms of Southern Europe.
Apart from not using DCF, several areas of DCF analysis were misapplied. This study
provides those evaluating investment projects or conceiving capital budgeting manuals or
policies with knowledge about common pitfalls that, if acted upon, could improve
decision-making.
It is possible to underline some differences between firms of different countries.
French firms have familiarity with capital budgeting techniques, but there is a lot of lacks
in their process. Spanish and Italian firms have more problems, and companies should
provide training for managers and analysts to ensure that capital budgeting tools, in
general, and DCF, in particular, are applied in accordance with the normative textbook
approaches. Some areas that need to be emphasised during training and considered in
decision-making are as follows:
 DCF;
 the superiority of NPV over PP and IRR;
 multiple discount rates for different projects or divisions with different risk;

Capital budgeting in Europe 353
 interest expenses to disregard when computing expected cash flows;
 whether the WACC is the proper discount rate rather than a single source
of financing;
 dedicated staff;
 standard models;
 supportive capital budgeting information systems to ensure readily available
parameters such as expected economic life and inflation rates;
 software products to make the required analysis easier;
 post-investment audits; and
 training and review for compliance.
These considerations show the main problems in the application of capital budgeting
techniques in Southern European SMEs. The use of PP and IRR demonstrates that a large
number of firms have short-term vision. The use of IRR may be a direct result of its
reporting simplicity. The NPV method is complex and requires many assumptions at
each stage. The IRR method simplifies projects to a single number that management can
use to determine whether a project is economically practical. For any long-term project
with multiple cash flows at different discount rates or with uncertain cash flows, the IRR
is not good for much more than presentation value.
Other problems are linked to staff training. In a large number of the sample firms, the
financial decisions were made by administrators who lacked proper training. Thus, in the
definition of the cost of capital, firms have unprepared staff. In fact, the primary variables
to be determined for calculating WACC are the relative debt and equity values, the cost
of debt, and the cost of equity. While the relative debt and equity values can be easily
determined, calculating the costs of debt and equity can be problematic. In calculating
each component, we are given many different options and proxy values.
The real problem is the lack of a post-investment audit. This is a significant
weakness, because they do not have a perception of the benefits of post-investment audits
in the capital budgeting process. In fact, the post-audit is an important aspect that can
help the firm compare its actual results with the forecasted results and explain any
differences. A post-investment audit may be performed to provide management with
feedback about the performance of a project, so that management can compare the results
to the costs and benefits expected at the time the project was selected.
Also French firms – characterised for the bigger size and the presence of qualified
financial staff – have problems in this stage. The review process is not considered
important for all firms, and this behaviour shows that managers-entrepreneurs continue to
follow the same capital budgeting scheme, without any changes: they have difficult to
consider any comments from the review process. Maybe the problem is associated with
the complexity of the review process. In fact, it requires many resources (e.g. software,
competence) that are not available to the smaller firms.

354 M. Rossi
6 Conclusions, managerial implication and
research limitations
This research has revealed the nature of capital budgeting practices in some countries of
Southern Europe. In particular, different variables in capital budgeting practices were
considered: the country, the impact of the business size, the process of capital budgeting
and the association between certain variables and capital budgeting. In some instances,
the results were contrary to our theory: the payback method remains a popular method,
despite its disadvantages. The analysis for countries shows that there are not big
differences between firms. French firms present some different results, but there are not
significant differences between countries.
This research has demonstrated that capital budgeting decision-making is a complex
process and that it is undervalued by SMEs. In fact, in these firms, business owners are
directly responsible for capital budgeting decisions. For most firms in the sample, the
capital budgeting decisions were made by people who lacked appropriate training (Rossi
et al., 2012).
Alike Graham and Harvey (2001) and Brounen et al. (2004), this research documents
fundamental differences between large and small firms when analysing corporate finance
practices. The results show that large firms are likely to use more sophisticated
techniques when it comes to evaluating risky projects: findings show that large firms are
more likely to use NPV criteria. Moreover, the results show that large firms are apt to
utilising more sophisticated, risk-matched discount rates instead of a standard firm cost
of capital. This consistent difference in corporate finance practice along the size
dimension is an intriguing result, which might help to understand the well-documented
size anomalies in the asset pricing literature.
The limitations of the paper are the result of its very nature: it is a largely conceptual
paper. Empirical research is therefore needed to test and validate the essentially
preliminary framework developed and the (well-based) assumptions made towards its
development. The important limits are as follows:
1 The definition of company size was based only on the number of employees. Other
indicators of business size, such as capital employed and turnover, were not
considered;
2 The research did not investigate whether the use of more than one method in capital
budgeting has any impact on the financing of capital budgeting expenditures and to
what extent it affects the accept/reject decision.
This research is, in effect, exploratory, and its findings are far from final. They instead
represent a starting point or a basis for further research and analysis. For this reason, the
empirical results should be interpreted in view of some limitations: the sample of firms is
random and does not fully conform to the criteria of statistical representation; and the
sample of companies could be expanded both numerically and geographically.

Capital budgeting in Europe 355
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Note
1 During the period of research, the prime lending interest rate was approximately 9.2%.
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