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1. Introduction
Profitable long-term investments are vital for the sustainability and growth of a firm. The survival and vitality of a firm depend upon its ability to regenerate returns from long-term assets/investments through the proper allotment of capital (Ryan and Ryan, 2002; Arnold and Hatzopoulos, 2000). To increase the wealth of its shareholders, a firm needs to continuously identify, analyze and choose long-term investment projects that could help achieving these goals, i.e., increase in wealth, survival and growth. This process of selecting, analyzing and investing capital in long-term assets/investments which provide returns for more than one year is known as capital budgeting (Fabozzi and Peterson, 2002). Investing in efficient investment projects is crucial because resources are limited and firms must grow their value (Klammer et al., 1991).
Corporate financial policy also known as financial management is comprised of three major decisions, i.e., investment decisions, financing decisions and dividend decisions (Freeman and Hobbes, 1991). Capital budgeting decisions fall under the domain of investment decisions. These decisions play an important role in increasing the value of the firm (Slagmulder et al., 1995). Investment decisions are more important than financing and dividend decisions as these decisions have a complicated nature (Nurullah and Kengatharan, 2015) and they require significant resources and long-term financial commitment. Once the investment decisions are taken, it becomes impossible to manipulate them without incurring significant losses (Hall and Millard, 2010). To comprehend investment decisions, firms should consider it as a continual process based upon several interrelated steps.
In corporate finance literature, capital budgeting practices are grouped into investment analysis (capital budgeting techniques (CBT)), discount rate setting and risk analysis (Souza and Lunkes, 2016). Traditionally, CBT are classified into two types, i.e., naive (basic) techniques and sophisticated techniques (Haka et al., 1985). Naive CBT do not consider cash flows, time value of money and risk factors, whereas sophisticated techniques consider these factors while analyzing investment opportunities. Net present value (NPV), internal rate of return (IRR), modified internal rate of return (MIRR) and profitability index (PI) are considered as sophisticated CBT, whereas payback period (PBP) and accounting rate of return (ARR) are classified as naive CBT (Brigham and Ehrhardt, 2002).
Estimating the cost of capital is also a vital component of long-term investment decisions....