380 Part 4 Investing in Long-Term Assets: Capital Budgeting
Monte Carlo simulation is technically more complex than scenario analysis,
but simulation software makes the process manageable. Simulation is useful; but
because of its complexity, a detailed discussion is best left for advanced " nance
courses.^7(^7) To use Monte Carlo simulation, one needs probability distributions for the inputs and correlation coe$ cients
between each pair of inputs. It is often di$ cult to obtain “reasonable” values for the correlations, especially for
new projects where no historical data are available. This limits the use of simulation analysis.
A recent survey of executives in Australia, Hong Kong, Indo-
nesia, Malaysia, the Philippines, and Singapore asked several
questions about companies’ capital budgeting practices.
The study yielded the results summarized here.
Techniques for Evaluating Corporate Projects
Consistent with U.S. companies, most companies in this
region evaluate projects using IRR, NPV, and payback. IRR
usage ranged from 96% (in Australia) to 86% (in Hong Kong).
NPV usage ranged from 96% (in Australia) to 81% (in the Phil-
ippines). Payback usage ranged from 100% (in Hong Kong
and the Philippines) to 81% (in Indonesia).
Techniques for Estimating the Cost of Equity Capital
Recall from Chapter 10 that three basic approaches can
be used to estimate the cost of equity: CAPM, dividend
yield plus growth rate (DCF), and cost of debt plus a risk
premium. The use of these methods varied considerably
from country to country. (See Table A.) The CAPM is used
most often by U.S. firms. This is also true for Australian
firms, but not for the other Asian/Pacific firms, which
instead are more likely to use the DCF and risk premium
approaches.
Techniques for Assessing Risk
Firms in the Asian/Paci" c region rely heavily on scenario and
sensitivity analyses. They also use decision trees and Monte
Carlo simulation, but less frequently. (See Table B.)
Source: Adapted from George W. Kester et al., “Capital Budgeting Practices in the Asia-Paci" c Region: Australia, Hong Kong, Indonesia,
Malaysia, Philippines, and Singapore,” Financial Practice and Education, Vol. 9, no. 1 (Spring/Summer 1999), pp. 25–33.
CAPITAL BUDGETING PRACTICES IN THE ASIAN/PACIFIC REGION
Table A
Method Australia Hong Kong Indonesia Malaysia Philippines Singapore
CAPM 72.7% 26.9% 0.0% 6.2% 24.1% 17.0%
Dividend yield plus
growth rate 16.4 53.8 33.3 50.0 34.5 42.6
Cost of debt plus
risk premium 10.9 23.1 53.4 37.5 58.6 42.6
Table B
Risk Assessment
Technique Australia Hong Kong Indonesia Malaysia Philippines Singapore
Scenario analysis 96% 100% 94% 80% 97% 90%
Sensitivity analysis 100 100 88 83 94 79
Decision tree
analysis 44 58 50 37 33 46
Monte Carlo
simulation 38 35 25 9 24 35