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Comparative review on capital budgeting practices between Canada, Japan and Indonesia 1.

0 Introduction
The purpose of this review paper is to produce a comparative study on the similarity or differences between methods of capital budgeting in different countries which in this case are Canada, Japan and Indonesia. Those 3 countries are selected due to their striving economy presence in the world and also for their dissimilarities in the level of economic development. In general in could be said that Japan and Canada are both developed countries while Indonesia is a rapidly developing country. However, that being said, Japan is a culturally and linguistically isolated country from the rest of the world. During this era of globalisation, it would be interesting to see if those 3 geographically and culturally distinguished countries would adapt to a common way of capital budgeting method or evolved into 3 totally different entities in terms of capital budgeting. Why is capital budgeting so important? In order to determine a companys success and survival, effective investment decision-making is crucial. Ultimately, capital budgeting is a process to evaluate whether future cash flows based on a proposed investment is fully justified, given the risk and uncertainty of the cash flows. For example, when Company A wants to purchase a new equipment for future expansion of the company, the company has to determine that their investment would ensure payback for the cost incurred at the present and bring about further profit in the future by using the best from a variety of financial tools for the purpose of investment evaluation. Basically, the tools for evaluating capital investment can be categorized into 2 sections which in this case, are the Discounted Cash flow (DCF) and Non-discounted cash flow (Non-DCF) methods.

Discounted Cash Flow (DCF) Net Positive Value (NPV) Internal Rate of Return (IRR) Discounted Payback Period (DPP) Premium Payback Period (PPP) Profitability Index (PI) Real Option (RO)

Non-discounted Cash Flow (Non-DCF) Accouting Rate of Return (ARR) Simple Payback Period (SPP)

Figure 1 Table of two categories of method of capital budgeting DCF model takes into consideration the time value for money while Non-DCF does not. Most of the academic literature and textbooks specifically concerning on financial theory indicates that the company should put priority in the former choice for any decision making involving capital investment. Besides academic reasons, there are few factors that affect the type of methods used such as the duration and amount of the initial investment.

Basically, this paper reviews 3 academic journals that discuss about the same issue in hand but the studies done are in different locations. Hence, there are bound to be some differences in the preference of capital budgeting methods, factors that affect the usage of capital budgeting methods and also the risk analysis methods. Besides that, the paper will also discuss about the trend of capital budgeting method used in their respective countries and how they have evolved into todays system.

2.0 Methodology
The methodology of the three journals is very similar to each other. Firstly, surveys are sent to each respective countrys listed companies via emails. The emails are then addressed to the personnel in the company who is directly involved in capital budgeting or capital investment decision making. In general, the questions in the surveys consist of four parts a) Attributes of survey participants and companies involved. b) preference of capital budgeting method c) factors that determine the type of method d) method of determining the discount rate and risk analysis as well. The questions ask the participants to rank their answers on a Likert-like scale of 0 to 5 (where 0 = not used/never, 1 = unimportant/rarely, and 5 = very important/ always).

2.1 Response from the companies





CANADA 500 22 88 18.41% INDONESIA 229 0 108 47.16% JAPAN 2224 0 225 10.12% Figure 2 Percentage of responses from the surveys conducted Karim Bennouna sent his surveys to 500 firms listed in the Financial Post (FP500) magazine. The percentage of response from company is as high as 18.41% only. The respondents are mainly CFO in large Firms. Besides that, it is assumed that most of the large companies would use the DCF and other sophisticated techniques. Farah M. Leon, Mansor Isa and George W.Kester sent their surveys 229 companies listed in the Jakarta Stock exchange (KSX) and the percentage of response is the highest compared to Japan and Canada, 47.16%. The 72.2% of respondents consist of President of finance and Vice President of Finance who are directly involved in decision making of capital investment. For the case of author Tomonari Shinoda, 2224 firms listed on the Tokyo Stock Exchange was selected for the survey but only 225 responded the surveys which makes the percentage of response the lowest, 10.21%. In this survey, the recipients are mailed to those with managerial positions or involved in capital budgeting but not limited to the CFO position. One of the obvious similarities is that all the authors above sent their surveys to large companies which are listed on their respective countries stock exchange market. This is done under the assumption that listed companies represent accurately and correctly the current financial trend of their respective countries because they make up a large percentage of their

countries economy. Besides that, large firms normally adhere to a more structured and strict way of doing things and therefore more inclined to use DCF model and other sophisticated capital budgeting methods. Furthermore, larger firms would normally hire highly qualified CFOs/Managers with ample working experience and good educational background in finance. Hence, they would be more equipped to provide quality responses to the survey questions. One of the weaknesses on Tomonari Shinoda method is that the author does not provide demographic information of the survey participants while the other two excel in doing so. Information such as participants education background and companies size, net fixed asset, industry, period of listing, ownership and financial risk are important in determining the usage of DCF techniques in a company. Authors Farah M. Leon, Mansor Isa and George W. Kester successfully tabulate the factors and correlate them with the usage of DCF models by applying the Chi-square significance formula. The low percentage of response could be contributed by the secrecy of information asked and the lack of time of the recipients to answer the mails because they are generally CFOs of their respective companies.

2.2 Method of Capital Budgeting

COUNTRY CANADA INDONESIA JAPAN METHODS OF CAPITAL BUDGETING (%) NPV 94.2 63.6 30.5 IRR 87.7 63.6 24.5 PI N/A 42.1 0 DPP 0 0 20.4 PPP 0 0 5.9 SPP N/A 86.4 50.2 ARR N/A 40.9 30.3 RO 8.1 0 0.5

Figure 3 Preferred (Primary or secondary) method of calculating capital budget in percentage

tytt 2.3 Distribution of Methods of Capital Budgeting According to Countries

As discussed earlier, there is more than one methods of evaluating capital investment. Overall, the methods found or discussed from all three of the academic journals are Net Present value (NPV), Internal Rate of Return (IRR), Accounting Rate of Return (ARR), Simple Payback Period (SPP), Discounted Payback Period (DPP), Premium Payback Period (PPP), Real Option (RO), and Profitability Index. Not all methods are adopted by all three countries which means the some methods are globally shared among the three countries and others are more commonly used in their respectively countries compared to another. The distribution of methods according to countries is clearly shown in the subset graph below:-






Figure 4 Distribution of Capital Budgeting Methods According to Countries As seen from above graph, the globally accepted method of capital budgeting based on the three journals are NPV, IRR, ARR, and SPP. RO method is more commonly used between Japan and Canada compared to Indonesia while PI method is more commonly shared between Indonesia and Canada compared to Japan. In Japan, there is an apparent preference to the payback period method. Companies in Japan not only use simple payback period method but develop the Discounted Payback Period and Premium Payback Period as well. The chart above does not necessarily prove that the use of a specific method is non existence at all in a particular country but merely shows that some of the methods is not captured in the surveyed companies or very rarely used. Japan payback Reasons for different payback RO method Risk analysis Conclusion Significant NPV and IRR RO and DPP, PPP method Risk analysis Determining the discounted rate