A Survey of Capital Budgeting essay

The payback method was selected as a secondary technique. Introduction The food service segment of the hospitality industry is rapidly growing. Entry y hospitality industry firms and others into these lines of business is not without risk. It is expected that such expansion will make winners out of the companies that acquire the best locations and create the most innovative facilities. It is also expected that companies lacking the resources to adapt and grow are likely to be hurt by the onslaught of competition (Value Line, 1994).

This expansion of the hospitality industry into food service, which is fixed asset intensive, has required firms specializing in this area to make capital investment decisions. It is therefore important to determine the UAPITA budgeting practices of these firms. Many studies have been performed on the capital budgeting practices of major U. S. Firms. Stigma and Forrester (1977), Stigma and Mercuric (1982), Brigham (1975), and Ferrymen (1973) are examples of published research on capital budgeting techniques employed by Fortune 50011000 U. S. Corporations.

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However, there have been relatively fewer studies determining the capital expenditure and capital acquisition policies of firms in the hospitality industry. Oyster and Seller (1981 ) compared the development of capital budgeting techniques employed by firms between 975 and 1980. Their study included both lodging and food service companies. Oyster and Seller concluded that even though the industry used more sophisticated methods in 1 980 than it did in 1975, the capital budgeting techniques used in the hospitality industry were misleading and naive as compared to other industries.

Chemicals and Damnation (1990) concluded that in 1 990, more hospitality industry firms used discounted cash flow measures in their decision making than they did in 1980. However, Chemicals and Damnation noted that many hotel chains still did not use formal risk analysis in heir decision-making processes. The The Journal of Hospitality Financial Management Chemicals and Damnation study was limited to large lodging chains.

Atkinson and Libretto (1997) studied the capital budgeting of casino/gaming firms and found AIR most frequently for their calculations; however, 43% of those responding indicated they used no technique to adjust for risk other than already incorporated in NP or AIR. The purpose of this study was to determine what capital budgeting and cost of capital procedures are being used in the food service segment of the hospitality industry and to compare he responses with those reported in the previous studies of capital budgeting techniques in the hospitality industry, where such a comparison Was possible.

The food service segment is growing rapidly as a result Of recent opportunities for growth. Food service operations normally require large investments in capital expenditures. Therefore, the expectation is that these firms would use more sophisticated capital budgeting procedures than the hospitality industry in general and would closer mirror the capital budgeting practices of major U. S. Firms. Sample Selection and Data Collection The firms surveyed for this study were identified as being in the restaurant industry by the Kiwi Index of Leading Companies.

A questionnaire was mailed to the Top 1 00 firms listed on the Kiwi Index with a stamped return envelope in order to collect the individual responses. A second mailing was sent three weeks later. A total of 28 responses of the questionnaires were returned with 21 being usable. The 1 990 study by Chemicals and Damnation mailed questionnaires to the 150 largest lodging chains. They received 46 usable responses for a response rate of 31% (Chemicals and Damnation, 1990). Oyster and Seller (1981) mailed questionnaires to 1,071 companies and received 120 responses for a response rate of 11%.

The Atkinson and Libretto (1997) study received only seven usable responses out of the 14 possible respondents. Measured by total assets, the firms in this study are quite large, as shown in Table 1 below. Nineteen of the 21 responding firms have assets greater than $100 million, while the other two responding firms have assets less than $1 00 million. Table 1 Asset size Of responding firms Asset Size Less Than $100 Million $1 O Million to $500 Million $500 Million to $750 Million

Over $750 Million Total Responses Number 2 12 5 21 percent 10% 57% 100% A Survey of Capital Budgeting Methods Used by the Restaurant Industry To determine the extent of the capital budgets in the sample, three questions were asked of the respondents. First, the respondents were asked about the size of their annual capital budget. Table 2 summarizes these results. Seven of the responding firms reported having annual capital budgets in excess of $50 million. Two of the firms reported an annual capital budget of less than $10 million and 12 companies had an annual capital budget between $1 0 and 50 million.

These results support the fact that this segment Of the hospitality industry is in a growth mode. Table 2 Size of annual capital budget Annual Capital Budget Less Than $10 Million $100 $20 Million $20 Million to $50 Million over $50 Million 7 Percent 33% The survey instrument asked the respondents to provide the size of a project that would require a formal analysis. Five firms (24%)indicated that the minimum project size was less than SSL 00,000 to require formal analysis, while one (5%) established a threshold of over $1 before formal analysis would be required.

The remaining fifteen respondents (71%)have established guidelines between $100,000 and SSL These findings are summarized in Table 3. Interestingly, 40% of the respondents to the 1 990 study by Chemicals and Damnation reported that expenditures in excess of $1 00,000 were considered major, and presumably would require formal analysis. The study by Oyster and Seller (1 981 ) reported significantly lower thresholds of project size to determine whether an analysis was required, which seems to indicate that minimum project sizes requiring formal analysis grew larger between the study dates.

Atkinson and Libretto (1997) found that five firms (71 formal analysis on projects of half a million or less. Table 3 Project size required for formal analysis Project Size Required for Formal Analysis Less Than $100,000 $500,000 $1 Million Greater Than $1 Million 9% Table 4 presents the project acceptance rate of those projects that are formally analyzed. None of the firms reported an acceptance rate of less than 10%. Three of the food service companies ( projects between and 25% of the time, six of the firms protect between 25% and 50% of the time, and 12 of the firms (57%) – expected due to the growth of the gaming segment of the industry.

Of the previous stud’s% of gaming firms accepted over 50% of their capital budgeting projects. Table 4 Percent of projects accepted Percent of Projects Accepted Less Than 10% 0% Capital Budgeting Procedures and the most important stage of the capital budgeting process. The results are shown in Table 5. As far as the most difficult stage in the capital budgeting process was concerned, 52% (1 1 )indicated that project definition and cash flow estimation was the most difficult stage.

Three respondents hat financial analysis and project selection was implementation as the most difficult stage, and three (14%)selected project review. As far as the most important stage in the capital budgeting process Was concerned, the most important stage.