Determinants of Capital Budgeting Practices and Risks Adjustment among Cambodian Companies

Abstract

This study uses a sample survey to analyze the capital budgeting practices of Cambodian companies in the manufacturing sector. The findings show that the payback period, NPV, discounted payback period and accounting rate of return are the most popular evaluation techniques. The study also finds that interest rate risk, as well as business cycle risk, are mainly adjusted with a discount rate, and the commonly used method for calculating the cost of capital is the after-tax cost of debt and the weighted average cost of capital (WACC). Furthermore, the finding suggests that the longer the existence of a company, the more likely for it to use the NPV method. The finding also reveals that the higher the amount of capital investment, the more it is likely to use the NPV method, while the smaller the amount of capital investment, the more likely the payback method will be used. With higher educational background, NPV and ARR are most likely the methods to be used in capital budgeting among the Cambodian firms.

Full text

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Ma’aji,'M.' M.,'&'Barnett,' C.'(2019).'Determinants' of'Capital' Budgeting'Practices'and'Risks' Adjustment'among' Cambodian'
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S'IL*"C(=)Capital!budgeting,!financial!management,!IRR,!NPV,!Risk,!Payback!period,!WACC.!
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Companies!need! to! invest! in! wealth-creating! assets! in! order! to! renew,! extend! or! replace!the!
means!by!which!they!carry!on!their!business.!Capital!investment!allows!companies!to!continue!
to! generate! cash! flows! in! the! future! or! to! maintain! the! profitability! of! existing! business!
activities!(Watson!&!Head,!2010).!Financial!management!is! concerned!with! the! planning! and!
controlling,! the! provision! of! resources! (financing! decision),! the! allocation! of! resources!
(investment! decision)! and! finally! the! control! of! resources! (whether! funds! are! being! used!
effectively! or! not).! This! will! ultimately! lead! to! achieving! the! primary! objective! of! financial!
management,!i.e.,!the!maximisation!of!shareholder!wealth.!The!continuity!and!sustainability!of!
every!company!will!rely!on!the!returns!generated!from!its!investments.!According!to!Miller!and!
Modigliani! (1961),! future! corporate! earnings! rely! on! the! company’s! investment! policy,! and!
investment!decisions!are!responsible!for!a!company’s!future!profitability!and!its!market!value.!
The! capital! budgeting! theory! lies! within! the! concept! of! shareholders’! wealth! maximization!
(Slagmulder!et!al.,!1995)!and!involves!investment!decisions!in!which!expenditures!and!receipts!
continue!over!a!significant!period!of!time!(Peterson!&!Fabozzi,!2002;!Dayananda!et!al.,!2002).!!!
!!!
Investment! decisions! have! significant! effects! on! the! long! term! financial! and! operational!
performance! of! companies! and! are! surrounded! with! complexity! and! uncertainty,! which!
present! particular! challenges! to! management! (Dempsey,! 2003).! Furthermore,! capital!
investments! involve! huge! capital! outflow;! it! has! its! unique! risks! and! estimations! about! the!
future! cash! flows.! The! uncertainty! of! future! cash! flows! and! other! estimation! difficulties! that!
exist! in! practice! have! resulted! in! the! development! of! various! risk! analysis! and! management!
science!techniques!to!supplement!traditional!present!value-based!decision!models!(Klammer!

Ma’aji,'M.'M.,' &'Barnett,'C.'(2019).'Determinants'of'Capital'Budgeting'Practices'and'Risks'Adjustment' among'Cambodian'Companies.'!"#$%&'()*+)
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et! al.,! 1991).! One! of! the! most! difficult! and! intractable! issues! faced! by! decision! makers! and!
researchers! is! how! to! identify,!capture! and! evaluate! uncertainties! associated! with! long-term!
investments.! Thus,! it! requires! a! rigorous! appraisal! to! weigh! its!cost! and! its! benefit! to! the!
business,! as! well! as! its! ultimate! impact! on! shareholders! wealth,! as! it! requires! prediction! of!
future! events! (Slagmulder,! 1997;! Abdel-Kader! &! Dugdale,! 1998).! All! capital! investments!
involve! risk! and! judgement.! A! disciplined! approach! helps! management! to! make! rational!
decisions! based! on! the! probable! impact! of! an! investment! on! the! future! of! the! business.! The!
presentation!of!the!proposed!investment!to!the!decision!makers!is!as!important!as!the!process!
of! gathering! and! evaluating! information.! The! way! such! a! presentation! is! made! often!
determines!the!extent!to!which!the!appraisal!influences!the!decision.!!
!
The!main!aim!of!this!research!is!to!investigate!the!prevailing!capital!budgeting!practices!when!
making! investment! decisions! by! Cambodian! companies.! This! survey! of! prevailing!capital!
budgeting! practices! within! Cambodian! companies! includes! the! following:! (1)! examining! the!
capital!budgeting!methods!used!in!the!evaluation!of!an!investment!proposal!and!(2)!analysing!
the!risk!techniques!of!capital!budgeting!used!in!adjusting!risk!in!investment!proposals!and!(3)!
determinants!of!capital!budgeting!methods!among!Cambodian!companies.!During!the!last!two!
decades,!Cambodia!experienced!a! strong! economic!growth,!sustained!an!average!growth! rate!
of!7.6!percent!between!1994!to!2015,!ranking!sixth!in!the!world!and!the!economy!is!expected!
to! remain! strong! over! the! next! five!years! (World! Bank,! 2017).! Cambodia! has! attained! lower!
middle-income! status! as! of!2015,! with! gross! domestic! product! (GDP)! per! capital! reaching!
US$1,270,!driven!by!garment!exports!and!tourism.!Cambodia!has!also!experienced!tremendous!
amount! of! business! investment! not! only! from! local! demand,! but! also! heightened!foreign!
interest!in!investment!(Turunen!&!Zhou,!2017).!!
!
For! example,! according! to! statistics! from! the! National! Bank! of! Cambodia! (NBC),! total! trade!
between! Cambodia! and! the! rest! of! the! world! in! 2016! equalled! US$29! billion,! around! 161!
percent! of! the! country’s! GDP.! Exports! from! Cambodia! reached! US$11! billion,! while! imports!
totalled!US$18!billion.!Foreign!direct!investment!(FDI)!into!Cambodia!increased!by!25!percent!
in! 2016! amounting! to! $2.15! billion,! most! of! which! were! channelled! into! the! financial! and!
manufacturing! sectors! (Chan,! 2017).! The! investment! inflow! from! foreign! countries! mostly!
went!to!the!financial!sector,!especially!to! banking,!due!to! the!increase!in!banking!institutions’!
capital! reserves! and! the! manufacturing! sector.! The! reasons! behind! the! increasing! capital!
investments!are! underpinned! by! peaceful! domestic! environment,! improved! investors’!
confidence,!favourable!macroeconomic!conditions,!and!increased! capacity!utilization!together!
with! expansion! of! economic! activity! (Turunen!&! Zhou,! 2017).! Therefore,! nowadays,! capital!
budgeting! practices! play! a! significant! role! than! ever! before!and,! to! the! best! of! researchers’!
knowledge,!there!has!not!been!research!on!capital!budgeting!practices!in!Cambodia.!Thus,!this!
research!has!been!designed!to!investigate!prevailing!capital!budgeting!practices!in!Cambodia.!
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Different! authors!define! the! capital! budgeting! in! different! ways.! For! example,! according! to!
O'Sullivan!and! Sheffrin!(2003),! ‘capital! budgeting! is! the! planning! process! used! to! assess!
whether! an! organization's! long! term! investments! such! as! replacement! of! machinery,! new!
machinery,!new! products,! new! plants! and! research! development! projects! are! worth! the!
funding!of!cash!through!the!firm's!capital!resources’.!It!is!the!process!of!allocating!resources!
for!major! capital,! or! investment,! expenditures.! One! of!the!primary!goals! of! capital! budgeting!
investments! is! to! increase! the! value! of! the! firm! to! the! shareholders! (O'Sullivan!&! Sheffrin,!
2003).!Similarly,!Dayananda!et!al.!(2002)!defined!capital!budgeting!as!mainly!related!to!sizable!

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investments! in! long-term! assets,! which! includes! either! tangible! (i.e.! property,! plant! or!
equipment)!or!intangible!assets!(i.e.! new! technology,! trademarks).! Regardless!of!their!nature!
(tangible! or! intangible),! investment! projects! require! careful! evaluation! as! they! require!very!
large!amounts!of!cash!to!be!raised!and!invested,!and!they!will!determine!whether!the!company!
is!profitable!in!the!future!(Dayananda!et!al.,!2002).!!Varshney!and!Maheshwari!(2014)!both!see!
capital!budgeting!as!a! step!by!step!process!that! businesses!use!to!determine!the! merits! of!an!
investment!project.!The!decision!of!whether!to!accept!or!deny!an!investment!project!as!part!of!
a!company's!growth!initiatives!involves!determining!the!investment!rate!of!return!that!such!a!
project!will!generate.!
!
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The!specific!capital!budgeting!procedure!that!a!manager!uses!depends!on!a!manager’s!level!in!
the! organisation,! size! and! complexity! of! the! project! being! evaluated,! and! the! size! of! the!
organisation.! Organisations! seek! to! select! the! best! or! most! profitable! investment! projects!
through! a! carefully! designed! process,! so! that! they! can! maximise! the! return! to! their!
shareholders.!They!also!seeks!to!avoid!the!negative!strategic!and!financial!consequences!which!
could!follow!from!poor!investment!decisions.!The!typical!steps!in!the!capital!budgeting!process!
highlighted!by!Stowe!and! Gagne! (2018)!is!shown!in!Figure! 1.!However,! the!capital!budgeting!
process!could!be!dynamic,!not! static! and! could! be!influenced!by!many!changing!factors!in! an!
organizational!environment.!
!
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The!process!starts!from!generating!ideas!i.e.!to!generate!a!proposal!for!investments!and!there!
could! be! various! reasons! for! taking! up! investments! in! a! business.! The! second! step! in! the!
process! is! to! analyse! the! individual! proposals! i.e.! collecting! information! and! selecting! all!
correct!criteria!to!judge!the!desirability!of!the!proposals.!This!has!to!match!the!objective!of!the!
firm!to!maximize!its!market!value.!The!third!step!is!to!plan!the!capital!budget!i.e.!organising!the!
profitable!proposals!into!a!coordinated!whole!that!fits!within!the!company’s!overall!strategies.!
Finally,! monitoring! and! post-auditing! i.e.! involves! comparison! of! actual! results! with! the!
planned!ones.! Unfavourable! results! are! identified! and! analysed;! resolving! the! various!
difficulties!of!the!projects!helps!for!future!selection!and!execution!of!the!proposals.!
!
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Over! the! last! three! decades,! significant! research! has! been! conducted! on! capital! budgeting!
practices!among!companies.!However,!a!review!of!this!literature!reveals!inconsistent!findings:!
financial!managers!and!academics!have!not!been!in!full!agreement!as!to!the!choice!of!the!best!
capital! budgeting! method.! Therefore,! there! is! no! such! defined! method! or! model! for! the!

Ma’aji,'M.'M.,' &'Barnett,'C.'(2019).'Determinants'of'Capital'Budgeting'Practices'and'Risks'Adjustment' among'Cambodian'Companies.'!"#$%&'()*+)
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selection! of! a! proposal! for! investments! as! different! businesses! have! different! requirements.!
The!literature!reveals!net!present!value!(NPV),!internal!rate!of!return!(IRR),!modified!internal!
rate!of!return!(MIRR),!payback!period!(PB),!discounted!payback!period!(DPB),!accounting!rate!
of!return!(ARR)!and!profitability!index!(PI)!as!the!more!prevalent!capital!budgeting!methods!in!
today’s!business! world! (Elumilade! et! al.,! 2006;! Maquieira! et! al.,! 2012;! Ryan! &! Ryan,! 2002).!
These!capital! budgeting! methods! can! be! either!discounted! cash! flow! (DCF)! methods! or!non-
DCF!methods.!The!DCF! is!an!application!of!the! time!value!of!money!concept,! i.e.!the!idea!that!
money!to!be!received!or!paid!at!some!time!in!the!future!has!less!value,!today,!than!an!equal!
amount!actually!received!or!paid!today.!DCF!analyses!use!future!free!cash!flow!projections!and!
discounts!them,!using!a! required! annual! rate,! to! arrive! at! present! value! estimates.! A! present!
value!estimate!is!then!used!to! evaluate! the! potential! for! investment.!Non-DCF!do!not!use!the!
concept!of!time!value!of!money!or!discount!the!free!cash!flow!projection.!Largely,!NPV!and!IRR!
are!considered!DCF!methods,!and!PB!and!ARR!are!non-DFC!methods.!
!
Early!studies!generally! report!DCF!models!to!be! the!least!popular!capital! budgeting!methods.!
This! might! be! attributed! to! the! lack! of! financial! sophistication! and! limited! use! of! computer!
technology!in!that! era.!Therefore,! payback!technique!and!the!ARR! as! non-DCF!were!the!most!
preferred!methods!(Pike,!1996;!Schall,!Sundam!&!Geijsbeek,!1978).!However,!with!the!modern!
financial! theory,! studies! have! shown! that! DCF! model! have! now! become! the! most! prepared!
capital! budgeting! methods.! Arnold! and! Hatzopoulos! (2000)! found! that! practitioners! placed!
greatest! emphasis! on! the! discounting! techniques! (NPV! and! IRR)! with! NPV! preferred! to!IRR!
(97%!of!large!firms!used! NPV;! 84%!used!IRR;!66%!used!payback).!However,! among! the!DCF!
methods,! through!the! literature,! NPV! has! trailed! IRR! in! management! preference.! Managers!
have! argued! that! the! perception! of! a! percentage! return! is! more! easily! understood! and!
comparable!than!an!absolute!dollar!value!increase!in!shareholder!wealth!(Liu!&!Stowe,!2005).!
Therefore,!in! the!past,!managers!have!chosen!IRR!over!NPV.!Management!view!IRR!as!a!more!
cognitively! efficient! measure! of! comparison! (Liu! &! Stowe,! 2005).! However,! academics! have!
long!argued!for!the!superiority!of!NPV!over!IRR.!
!
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The! study! focuses! on! the! manufacturing! companies! in! Cambodia! and! a! self-reported!
questionnaire!has!been!administered!for!the!collection!of! data.!The! manufacturing! as! well! as!
other! industrial! sector! accounts! for! 59! percent! of! the! total! GDP,! while! the! services! sector’s!
contribution! to! the! GDP!is! 41! percent! (World! Bank,! 2016).! The! manufacturing! sector,!
especially! the! garment! industry,! is! the! foremost! driver! of! Cambodia’s! economic! activity!
expansion,!thus!the!selection!of!the!manufacturing!sector!to!be! the! subject! of! this! study.! The!
questionnaire! adopted! was!originally! used! and! developed! in!previous! studies! to! facilitate!
comparison! (Elumilade! et! al.,! 2006;! Graham! &! Harvey,! 2001;! Maquieira! et! al.,! 2012;! Ryan! &!
Ryan,!2002;!Verma!et!al.,!2009).!The!structured!questionnaire!includes!closed!ended!questions!
inquiring!use!of!discounted/non-discounted!and!risk-adjusted!techniques!of!capital!budgeting,!
cost!of!capital!calculations,!and!the!capital!budgeting!process!and!activities!on!a!Likert!scale!of!
1!to!5.!
!
A! total! of! 130! questionnaires! were! distributed! to! the! financial! managers/CFOs! on! the! basis!
that!they!are! most! likely! to! be! involved!in!evaluating! investment! projects! of! the! company.! A!
covering!letter!attached!to!each!questionnaire!served!as!an!introduction!to!the!purpose!of!the!
survey!and!assured!the!confidentiality!of! the! information! supplied!by!each!respondent.!In!an!
attempt! to! increase! the! response! rate,! the! questionnaires! were! presented! in-person! and!
appointments!were!scheduled!in!advance.!Fifty!three!usable!responses!were!received,!given!a!
response! rate! of! 40.8! percent,! which! is! comparable! to! similar! surveys.! Data! collected! were!

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presented! and! analysed! using! descriptive! statistics! and! inferential! statistics! (including! mean!
and!percentage!analysis).!
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The! classification! of! the! educational! background!of! the! financial! managers! is! presented! in!
Table!1.!Sixty!percent!(n=32)!of!managers!had!undergraduate!degree!qualification,!followed!by!
a!34!percent!of!them!having!masters/MBA!(n=18).!PhD!and!other!qualifications!where!held!by!
2!percent!(n=1)!and!4!percent!(n=2),!respectively.!
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1.9!
Masters/MBA!!!
18!
34.0!
Undergraduate!degree!
32!
60.3!
Any!other!qualification!!!!
2!
3.8!
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The!sampled!companies!have!been!classified!in!terms!of!number!of!years!they!are!in!business.!
The! years! were! classified! into! 5! categories! as! shown! in! Table! 2.! Based! on! the! respondents’!
feedback,!47!percent!of!the!companies!have!been!in!business!for!between!10!and!20!years!(n=!
25),! thirteen! companies! (25%)! are! considered! to! be! newly! established! businesses! that! have!
been! operating! for! less! than! 10! years.! Nineteen! percent! of! the! respondents! have! been! in!
business!for!between!31!and!40!years,!while!the!remaining!9!percent!of!the!respondents!have!
stayed!in!business!for!between!21!and!30!years!(n=!5).!!
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The!companies!have! been!classified!in!terms!of! size!of!the!capital!budgets! that!they!invested.!
The!size!of!the!capital!budgets! is! defined! as! total! annual! spending! in! term! of! property,! plant!
and!equipment!(PPE).! As! shown! in! Table! 3! below,! 57!percent!of!companies’! size! in! terms! of!
their!capital! budgets! is! above! $100,000! but! below! $10! million,! while! 16! of! the! companies!
(accounting!for!30%)!have!a!capital!budget!up!to!$100,000.!Six!companies!(representing!11%)!
mentioned!the!size!of! their!capital!budget!to!be!between!$10! million! and!$100!million,!while!
only! one! company! has! a! capital! budget! between! US$100! million! to! US$500! million.! The!
reasons!behind!this!huge!investment!could!be!as!a!result!of!the!increased!growth!witnessed!in!
the!manufacturing!sector!and!increased!flow!of!FDI!into!Cambodia.!This!will!increase!the!level!
of! intense! competition! among! companies! and! forcing! businesses! to! invest!in! modern!
technological!equipment!and!facilities!in!order!to!remain!relevant!and!competitive.!

Ma’aji,'M.'M.,' &'Barnett,'C.'(2019).'Determinants'of'Capital'Budgeting'Practices'and'Risks'Adjustment' among'Cambodian'Companies.'!"#$%&'()*+)
,-(%.'(()/'('0"#$1)72341'171-182.'
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!
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176!
K0:3')8)
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7*4)*+))#*@B0.%'()
`)*+)#*@B0.%'()))
up!to!$100,000!
16!
30.2!
<$10!million!
30!
56.6!
$10-$100!million!
6!
11.3!
$100-$500!million!
1!
1.9!
>$500!million!
0!
0!
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)
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9-"B*(')*+)%.&'(;@'.;)+*")#0B%;03):-CD';%.D)
Table!4!presents!the!survey!findings!on!the!purpose!of!investment.!Forty!seven!percent!of!the!
respondent! (n=20)! stated! that! the! dominant! motivation! for! making! investment! is! for!
expansion!into!new!business!and!existing!business.!Moreover,!13! companies! (24%)! invest! in!
order!to!expand!existing!business.!Nine!percent!of!the!respondent!mentioned!that!the!reason!is!
for! equipment! replacement! and! modernization! of! their! operation.! Expansion! of! existing!
business! and! equipment! replacement! is! one! the! reasons! of! investment! as! mentioned! by! 8!
percent! of! the! respondents! (n=4),! while! another! 8! percent! stated! that! expansion! into! new!
business!(i.e.,! diversification)! is! the! motive! behind! the! investment.! A! majority! of! the!
respondents! mentioned! that! expansion! into! existing! business! is! the! main! reason! for! the!
investment.!This!could!be!in!the! form!of!increased! production!capacity,!company!acquisitions!
and! the! introduction! of! electronically! integrated! operations,! thereby! achieving! economies!of!
scale,! increased! sales! or! product! volume! to! get! more! income! and! improve! performance! of!
company.!
!
K0:3')\)
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9-"B*(')*+)?.&'(;@'.;)))
7*4)*+)#*@B0.%'()
`)*+)
#*@B0.%'()
Expansion!into!new!business/diversification!only!!!
4!!!
7.5!
Expansion!into!existing!business!only!!!
13!!!
24.5!
Equipment!replacement!and!modernization!only!!!
5!!!
9.4!
Expansion!into!new!and!existing!business!only!!!
25!!!
47.2!
Expansion!of!existing!business!and!equipment!replacement!!!
4!!!
7.5!
Expansion!into!new!business!and!equipment!replacement!!!
1!!!
1.9!
Expansion!into!new!business,!existing!business!and!
equipment!replacement!!!
1!!!
1.9!
K*;03)))
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100.0!
J*-"#'=)J-"&'I)<0;0)))
!
!
)
R0#;*"()C';'"@%.%.D)#0B%;03):-CD';%.D)@';$*C)
The!sample!firms!were!asked! about!the!factors!determining!the!selection!of!capital!budgeting!
method.!Table!5!presents!results! from! their! respective! managers.! The! most! important! factor!
determining! capital! budgeting! method! is! top! management! familiarity! (28.3%).! This! was!
followed! by! the! importance! of! the! project! (20.8%),! easy! and! understandability! (17%),!
experience!and!competence!(13.2%),!finance!theory!(11.3%)!and!informal!rule!of!thumb!with!

!
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just!7.5!percent.! Notwithstanding,!the!remaining!factor,!i.e.!other!factors!took!the! mean!value!
less!than!two!which!implies!“not!important”!in!deciding!capital!budgeting!decision.!
!
K0:3')a)
R0#;*"()C';'"@%.%.D)#0B%;03):-CD';%.D)@';$*C)
R0#;*"() ) )
7*4)*+)
#*@B0.%'()
`)*+)#*@B0.%'()
Finance!theory!
6!
11.3!
Experience!and!competency!
7!
13.2!
Informal!rule!of!thumb!
4!
7.5!
Importance!of!the!project!
11!
20.8!
Easy!and!understandability!
9!
17.0!
Top!management!familiarity!
15!
28.3!
Any!other!factors!
1!
1.9!
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!
!
!
More!so,!even!though!Cambodia!is!a!developing!market,!the!findings!show!increase!awareness!
and! quality! of! management! education.! Financial! managers! are! becoming! more! aware! of! the!
decision!aids!at!their!disposal!and!are!more!than!equipped!to!apply!the!benefits!of!information!
technology!explosion.!!
!
K0:3')c)
A0B%;03):-CD';%.D)@';$*C)
G';$*C()
7*4)*+)#*@B0.%'()
`)*+)#*@B0.%'()
Payback!(PB)!
18!
34.0!
Discounted!Payback!(DPB)!
9!
17.0!
Net!Present!Value!(NPV)!
10!
18.9!
Profitability!Index!(PI)!
3!
5.7!
Modified!Internal!Rate!of!Return!(MIRR)!
4!
7.5!
Internal!Rate!of!Return!(IRR)!
4!
7.5!
Accounting!Rate!of!Return!(ARR!or!ROCE)!
5!
9.4!
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A0B%;03):-CD';%.D)@';$*C()%.)B"0#;%#')
The!financial!managers!were!asked!to!respond!on!which!of!the!financial!analysis!technique(s)!
is!(are)!used!in!their!respective!businesses!for!the!appraisal!of!major!investments.!According!to!
the!respondents,!as!summarized!in! Table! 6,! payback! period! method! (PB)! (n=18)! is! the!most!
important!technique!used!to!evaluate!investment.! This!was!followed!by!the!net!present! value!
(NPV)!method!(n=10),!discounted!payback!(DPB)!(n=9)!and!accounting!rate!of!return!(ARR)!or!
ROCE!(n=5).!The! least! likely! methods! to! be! employed!by!the! respondent! are! internal! rate! of!
return!(IRR)!(n=4),!modified!internal! rate! of!return!(MIRR)!(n=4)!and!profitability! index!(PI)!
(n=3).!The!respondent!were!further!asked!to!indicate!which!of!the!capital!budgeting!method!is!
either!used!as!primary,!secondary!or!neither.!Results!are!presented!in!Table!7.!!
!
Ninety! five! percent! of! financial! managers! reported! that! PB! method! is! a! primary! method! for!
capital! budgeting,! whereas! 85! percent! of! the! managers! indicated! NPV!as! a! primary! method.!
Similarly,!23!percent!of!the!financial!managers!were!reported!to!use!DPB!as!a!primary!method,!
while!only!13!percent!of!the! managers!used!ARR!as! a!primary!method.! The!result!also!shows!

Ma’aji,'M.'M.,' &'Barnett,'C.'(2019).'Determinants'of'Capital'Budgeting'Practices'and'Risks'Adjustment' among'Cambodian'Companies.'!"#$%&'()*+)
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that! the! managers! preferred! to! use! IRR! (79%),! DPB! (77%),! PI! (64%)! and! ARR! (34%)! as!
secondary!methods.!Furthermore,!the! result! shows! that!MIRR!is!neither!used!as! primary! nor!
secondary!method.!The!PB!and! the! NPV! methods! are! reportedly! being! used! as! both! primary!
and! secondary.! Moreover,! the! survey! results! also! indicate! the! use! of! multiple! techniques!
among!the!companies!in!Cambodia;!some! respondents! used! more! than!one!financial!analysis!
technique!when!evaluating! investment! projects! (some! technique! as!primary,!while! others! as!
secondary).! This! result! is! consistent! with! other! studies! (e.g.! Alkaraan! &! Northcott,! 2006;!
Arnold!&!Hatzopoulos,!2000;!Lingesiya,!2015).!
!
K0:3')5)
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G';$*C()
9"%@0"I)
J'#*.C0"I))
7'%;$'")
Payback!(PB)!! ! !
95%!(50)!
5%!(3)!
-!
Discounted!Payback!(DPB)!
23%!(12)!
77%!(41)!
-!
Net!Present!Value!(NPV)!
85%!(45)!
15%!(8)!
-!
Profitability!Index!(PI)!
-!
64%!(34)!
36%!(19)!
Modified!Internal!Rate!of!Return!(MIRR)!
-!
-!
100%!(53)!
Internal!Rate!of!Return!(IRR)! !
-!
79%!(42)!
21%!(11)!
Accounting!Rate!of!Return!(ARR!or!ROCE)!
13%!(7)!
34%!(18)!
53%!(28)!
J*-"#'=)J-"&'I)<0;0)))
!
!
!
!!!!!Note:!Number!in!parenthesis!represents!the!number!of!companies.!!
!
V(;%@0;%*.)*+);$')A*(;)*+)A0B%;03)
The!respondents!were!asked!to!report!on!how!their!respective!companies!derive!the!discount!
rate!in!the!appraisal!of!major! capital!investments.!Table!8!presents!information!on!usage!and!
estimation!of!the!cost!of!capital.!A!substantial!majority!of!respondent!companies!(98%)!used!a!
cost! of! capital! in! their! investment! evaluation! techniques,! while! only! about! 2! percent! of! the!
managers! indicated! that! they! do! not! use! cost! of! capital!in! their! capital! budgeting! analysis.!
Results! show! that! cost! of! debt! after! tax!is! the! most! prevalent! method! in! calculating! cost! of!
capital!(n=16).!The!next!widely!used!methods!are!the!weighted!average!cost!of!capital!(WACC)!
(n=12),!the! cost! of! debt! before! tax! (n=8),! cost! of! equity! derived! from! capital! asset! pricing!
model! (CAPM)! (n=6)! and! average! historical! returns!(n=5).! Cost! of! equity! derived! from!
dividend! growth! model! (DVM)! and! an! arbitrary! chosen! figure! are! not! popular! methods! in!
calculating!cost!of!capital!amongst!Cambodian!companies.!The!findings!highlight!that!the!major!
source!of!finance!to!fund!capital!investment!in!Cambodia!is!through!debt!finance.!
!
K0:3')[)
V(;%@0;%*.)*+);$')A*(;)*+)A0B%;03)
G';$*C(!
7*4)*+)#*@B0.%'()
`)*+)
#*@B0.%'()
Cost!of!debt!before!tax!
8!
15.1!
Cost!of!debt!after!tax!
16!
30.2!
Cost!of!equity!derived!from!Dividend!Growth!model!(DVM)!
3!
5.7!
Cost!of!equity!derived!from!Capital!Asset!Pricing!model!(CAPM)!
6!
11.3!
Weighted!average!cost!of!capital!(WACC)!
12!
22.6!
Average!historical!returns!
5!
9.4!
An!arbitrary!chosen!figure!
2!
3.8!
None!
1!
1.9!
K*;03)
a8)
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J*-"#'=)J-"&'I)<0;0)))
!
!

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/%(E)+0#;*"()0.C)0CF-(;@'.;()
Appraising! long-term! capital! investments! can! be! quite! challenging!to! businesses! due! to! the!
uncertainty!surrounding!the!projects’!cash!flows.!Therefore,!risk!factors!should!be!considered!
and! adjusted! for.! Some! of! this! risk! factors! could! be! unexpected! inflation,! interest! rate!
movements,!GDP!growth!or!business!cycle!risk,!movement!in!commodity!price!and!movement!
in!foreign!exchange!among!other!factors.!The!results!of!the!survey!as!depicted!in!Table!9!shows!
that!interest!rate!risk!and!business!cycle!risk!are!mainly!adjusted!by!discount!rate!(63!and!85!
percent,! respectively).! In! contrast,! risk! of! unexpected! inflation,! foreign! exchange! risk! and!
commodity!price!risk!are!mainly!adjusted!by!cash!flows!(70,!55!and!94!percent,!respectively).!
Furthermore,!risk! of!unexpected!inflation!and!foreign!exchange!risk!are!both!adjusted!by!cost!
of!capital!as!well!as!cash!flow!according!to!some!respondents,! while! 6! and! 10! percent! of! the!
respondents!neither!adjust!for!risk!of!commodity!price!movement!and!foreign!exchange!risk!
respectively.!!
!
K0:3')d)
/%(E)+0#;*"()0.C)0CF-(;@'.;()
/%(E)R0#;*"()
!CF-(;)#*(;)*+)
#0B%;03)
!CF-(;)#0($)
+3*L))
,*;$)
7'%;$'")
Risk!of!unexpected!inflation!
25%!(13)!
70%!(37)!
5%!(3)!
-!
Interest!rate!risk!
63%!(33)!
37%!(20)!
-!
-!
GDP!or!business!cycle!risk!
85%!(45)!
15%!(8)!
-!
-!
Commodity!price!risk!
-!
94%!(50)!
-!
6%!(3)!
Foreign!exchange!risk!
15%!(8)!
55%!(29)!
20%!
(11)!
10%!(5)!
J*-"#'=)J-"&'I)<0;0)))
!
!
!
!
!!!!!!!Note:!Number!in!parenthesis!represents!the!number!of!companies.!!
!
<V2VU>9?7X)!7<)KVJK?7X)^_9>K^VJVJ)
The!discussion!in! the! previous! sub-sections! was! based! on! comparing!averages.!Although!the!
discussion!provided!some!interesting!results! on! the!use!of!capital!budgeting!methods,!in! this!
section,! the! study! goes! one! step! further! by! performing! multivariate! regression! analysis! in!
order!to!test!hypotheses!developed.!The!objective!is!to!investigate!the!determinants!of!capital!
budgeting!methods.!In!this!regards,!three!hypotheses!were!developed!as!follows:!
H1.!The!age!of!the!company!affects!the!selection!of!capital!budgeting!methods.!
H2.!The!size!of!capital!budget!affects!the!selection!of!capital!budgeting!methods.!
H3.!The!educational!qualification!of!CFO!affects!the!selection!of!capital!budgeting!methods.!
!
With!respect!to!the!above!hypotheses,!the!study!investigated!the!determinants!of!four!different!
capital!budgeting!methods,!i.e.!the! PB,!NPV,!IRR!and!ARR!methods.!The!MIRR!and!PI!methods!
were! left! out,! since! the! results! in! Table! 6! and! 7!showed! that! the! methods! were!the! least!
preferred!method!among!Cambodian!companies.!!
!
To!test!the!hypotheses,!estimations!are!carried!out!using!the!binary!logistic!regression!method.!
Binary! logistic! regression1!deals! with! situations! in! which! the! observed! outcome! for! a!
dependent! variable! can! have! only! two! possible! outcome.! Using! this! approach! to! test! the!
research!hypotheses!is!also!applied!by!Hermes,!Smid!and!Yao!(2007).!
!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!
!
1!To!investigate!the!determinants!of!capital!budgeting!method,!a!logistic!regression!model!of!the!following!form!is!
estimated:!
Zi!=!α0!+!β1SBUDGETi,t!+!β2EDUCi,t!+!β3AGEi,t!+!µt!!

Ma’aji,'M.'M.,' &'Barnett,'C.'(2019).'Determinants'of'Capital'Budgeting'Practices'and'Risks'Adjustment' among'Cambodian'Companies.'!"#$%&'()*+)
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180!
Zi!=!β’xi!+!ui!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!(1)!
!
The!dependent!variables!(Zi)!are!binary!dummy!variables!created!as!follows:!PB!=!1!if!the!label!
value!of!a!firm!for!the!PB!method!is!4,!it!is!0!if!the!label!value!of!a!firm!is!otherwise;!!NPV!=!1!if!
the!score!of!a!firm!for!the!NPV!method!is!3,!it!is!0!if!the!label!value!of!a!firm!is!otherwise;!IRR!=!
1! if! the! label! value! for! a! firm! for! the! IRR! method! is! 6,! it! is! 0! if! the! label! value! of! a! firm! is!
otherwise;!ARR!=!1!if!the!score!of!a!firm!for!the!ARR! method!is!7,!it!is!0!if!the! label!value!of!a!
firm!is!otherwise.!The! independent! variables!(xi)!are!also!binary!variables.!We! have! used! the!
following!variable!specifications:!SBUDGET!=!1!if!the!size!of!the!budget!is!less!than!10!million!
dollars,!it!is!0!if!the!size!of!the!budget!is!10!million!dollars!or!more;!EDUC!=!1!if!the!CFO!of!the!
firm!has!a!PhD!or!Master/MBA!degree,!it!is!0!if!(s)he!has!an!undergraduate!degree;!AGE!=!1!if!
the!firm!is!30!years!or!older,!it!is!0!if!firm!is!less!than!30!years.!ui!=!error!term;!Zi!ranges!from!–
α!to!+α.!
!
The! result! from! the! logistic! regression! is! presented! in! table! 10.! It! shows! the! result! for! the!
determinants!of!the!use!of!the!different!capital!budgeting!techniques.!Size!of!capital!budgeting!
budget!(SBUDGET)!and!educational!background!of!the!finance!managers!(EDUC)!are!the!most!
influential!determinant!of!capital!budgeting!method!among!Cambodian!firms.!Furthermore,!the!
results!show!a!significant!positive!coefficient!between!age!of!company!(AGE)!and!NPV;!and!it!is!
statistically! significant! at! the! 10! percent! level.! The! finding! suggests! that! the! longer! the!
existence!of!a!company,! the! more! likely! to! use! NPV! method.! Older! companies! probably!have!
more! experience! and! management! capabilities! (expertise).! Thus,! H1!is! supported! in! case! of!
NPV!and!not!supported!in!case!of!all!other!methods!(PB,!ARR!and!IRR).!!
!
K0:3')WZ))
<';'"@%.0.;()*+)A0B%;03),-CD';%.D)G';$*C()OU*D%;)!.03I(%(Q)
!
9,)
792)
!//)
?//)
Constant!
-0.398*!
0.544***!
-0.156!
2.645**!
SBUDGET!
-1.063***!
0.345**!
-0.432!
1.200!
EDUC!
0.966!
0.615*!
1.429**!
-0.159!
AGE!
-1.155!
1.258*!
1.207!
1.142!
!
!
!
!
!
McFadden!R2!
0.107!
0.09!
0.10!
0.07!
Number!of!
observations!
53!
53!
53!
53!
*,!**,!***!significant!at!10!percent,!5!percent!and!1!percent!levels!respectively.!The!McFadden!R2!
is!an!analogue!to!the!R2!reported!for!regular!OLS!regression!models.!
!
Moreover,! the! result! shows! a! negative! coefficient! between! SBUDGET!and! PB! which! is!
statistically!significant!at!the!1! percent!level.!The!larger!the!amount!of!capital!investment,!the!
less!likely!the!PB!method!will!be!used.!However,!there!is!a!positive!relation!between!SBUDGET!
and!NPV.!The!finding!shows! that!the!higher!the!amount!of!capital!investment,!the!more!likely!
the!NPV!method!will!be! used.! The!variables!are!statistically!significant!at! the! 5! percent!level.!
ARR! and! IRR! are! insignificant.! The! finding! is! consistent! with! previous! studies! where! they!
found! that! organisations! used! NPV! to! appraise! project! when! it! involved! huge! investment!
(Brounen!et!al.,!2004;!Verbeeten,!2006;!Hermes!et!al.,!2007).!Thus,!it!can!be!concluded!that!H2!
was!supported!in!case!of!NPV!and!PB,!and!not!supported!in!case!of!all!other!methods.!
!
On!the!other!hand,!with!higher!educational!background!(EDUC),!NPV!and!ARR!are!most!likely!
method! to! be! used! in! capital! budgeting.! The! result! shows! that! EDUC! is! positively! related! to!

!
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NPV!and!ARR!and!is!statistically!significant!at!the!10!percent!and!5!percent!levels!respectively.!
Financial!managers!that!are!highly!qualified! preferred!to!use!more!advanced!techniques!such!
as! NPV,! while! non-discounted! methods! like! PB! was! preferred! by! less! qualified! personnel.!
Graham! and! Harvey,! (2001)! and!Hermes! et! al.! (2007)! argued! that! managers! with! higher!
education! have! fewer! problems! in! understanding! more! sophisticated! capital! budgeting!
techniques!and!consequently,!they!preferred!to!use!them.!Thus,!H3!is!supported!in!case!of!NPV!
and!ARR.!
)
A>7AUTJ?>7)!7<)?G9U?A!K?>7J)
The! capital! budgeting! practices! of! a! sample! of! 53! manufacturing! companies! operating! in!
Cambodia! have! been! investigated.! The! results! revealed! that! the! most! important! factor!
determining!capital!budgeting! method!are!top!management! familiarity,!the!importance!of! the!
project! and! experience! and! competency.! PB! is! the! most! preferred! capital! budgeting! method,!
followed!NPV,!DPB!and!ARR.!Similarly,!the!study!finds!that!interest!rate!risk!and!business!cycle!
risk!are!mainly! adjusted!with!a!discount!rate,!and! the!commonly!used!method!for! calculating!
cost!of!capital!was!the! after!tax!cost!of!debt!and!the!WACC.! Furthermore,!the!findings!suggest!
that!the!longer!the!existence!of!a!company,!the!more!likely!to!use!NPV!method.!The!finding!also!
revealed!that!the!higher!the!amount!of!capital!investment,!the!more!likely!the!NPV!method!will!
be!used;! while! the! smaller!the! amount! of! capital! investment,!the! more! likely! the! PB!method!
will! be! used.! And! with! higher!educational! background,! NPV! and! ARR! are! most! likely! the!
methods!to!be!used!in!capital!budgeting.!
!
As!far!as!the!world!of!empirical!knowledge!is!concerned,!this!is!the!first!study!to!investigate!on!
capital! budgeting! practice! among! Cambodian! companies,! thus! it! make! a! contribution! to!
literature!on!practices!in!Cambodia!and!other!frontier!markets.!The!outcome!of!this!study!will!
be! useful! by! practitioners! in! order! for! them! to! understand! the! prevailing! capital! budgeting!
practices!at!their!respective!firms.! The! study!highlights!the!importance!of!firm’s!training!and!
improving!their!skills,!as!well!as!understanding!and!upgrading!the!competencies!of!their!staff’s!
performance.!This!is!because!educational!background!has!significant!influence!on!the!selection!
of! capital! budgeting! method.! The! outcome! of! this! study! also! signifies! the! importance! of! risk!
adjustment! in! capital! budgeting! decision.! Doing! so! will! help! the! organisation! to! find! out! the!
best!technique!to!maximise!shareholders’!wealth.!In!general,!this!study!serves!as!a!foundation!
for!future!research.!
!
!AS7>PUV<XVGV7K)
This!research!is!fully!supported!by!CamEd!Business!School,!Phnom!Pehn!Cambodia,!therefore!
the!authors!wish!to!express!gratitude!to!CamEd!Business!School!for!their!financial!support.!
!
/'+'"'.#'())
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