The Use of Capital Budgeting Techniques. An outlook from Italy

Capital Budgeting is one of the most important areas of financial management. Different techniques are used to evaluate Capital Budgeting projects: the payback period, the accounting rate of return, the present value and the internal rate of return and the profitability index. Graham and Harvey (2001, 2002) highlight that financial managers favour methods such as the Internal Rate of Return (IRR) or non-discounted Payback Period (PP) models over the Net Present Value (NPV), which is the model that scholars consider to be superior. Particularly, this research investigates a number of variables and associations relating to Capital Budgeting practices in Italian firms.The results revealed that PP, followed by NPV, is the most used method. There is a difference between large and small firms. This research shows that the more complex methods are most favoured by the large 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.A theory-practice gap remains in the Discounted Cash Flow (DCF) application among firms in Italy. 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.This study is exploratory research. The results represent 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.