262 Corporate Finance
Capital Budgeting in Select Large Companies^5
E I du Pont is a manufacturer of freon and a variety of industrial chemicals. At DuPont, corporate planning
department, an arm of the executive committee staff, provides broad guidelines for capital spending. The
company publishes a hurdle rate internally which is used as a first screen to sift out bad ideas. The planning
process works not decision by decision but business by business. Business plans will be drawn up to look
ahead one, two, and five and ten years into the future for each major business segment and this plan may or
may not involve major capital investment. If it does, the capital investment will be studied and preliminary
numbers drawn up. The net result is that the business plan has to make sense and the individual appropriations
within the business plan also have to make sense. There is greater emphasis on examining business plans in
general rather than individual projects. So, attractive businesses may not get funded.
EG&G has a strategic planning system that keeps track of entities called business elements—well-defined
businesses that have a strategy. The company has about 160 elements and 40 divisions. These elements
cover a variety of businesses. The company is managed through a planning and control process that consists
essentially of developing a strategic plan in spring. Each of the divisions prepares a strategic plan within
which they define business elements, their competitors, the competitive advantages and disadvantages, any
emerging new technology that might impact the business, etc. The company has review teams of two senior
operating managers, a planning executive and a financial executive, who review all of these operations in
this process. In addition to the spring planning process, in the fall, the company develops a plan that looks
ahead into the calendar year. The idea is to communicate the primary interests in the one-year plan. Most
capital investments appear in the strategic plan. Major projects are specifically listed in the one-year plan.
Decisions to actually proceed with a capital investment are documented and approved with a capital expen-
diture request. Approval authority is delegated very low in the organisation for projects of $ 0.5 million or
less. There is a corporate office review for projects greater than $ 0.5 m.
Ameritech uses Modified Internal Rate of Return and profitability index as decision criteria. Executives
are asked to come up with three estimates: the best case, the worst case and the most likely. The company
communicates to the people in the field to risk—adjust cash flows and not play with discount rate.
Hershey Foods Corporation uses a category system for classifying projects. The three major categories
are conventional capital, new products, and R&D. Projects are taken upon a priority basis. Each project is
individually reviewed. Major decision criteria used by the company are NPV and IRR.
The important point that emerges from the foregoing discussion is that a project has to pass through several
‘tollgates’ before being accepted as the concept of a dynamic project evaluation system (Exhibit 13.1).^6
SmithKline Beecham (SB) is a global pharmaceutical company with operations around the world. It
competes in a high-risk technically complex business. At any given time, the company’s dozens of projects
spread across both therapy areas and continents. SB wanted to overhaul its investment process in 1993.^7
Before the implementation of the new system executives rarely evaluated alternatives to a plan. Under the
new system, each project is to be evaluated under at least four alternatives: the current plan (the team would
follow the existing plan of activity), a ‘buy up’ option (the team would be given more to spend on the pro-
ject), a ‘buy down’ alternative (the team would be given less to spend on the project) and a minimal plan
(^5) FMA Round Table Discussion (1989). Financial Management, Spring.
(^6) Boquist, John A, Todd T Milbourn, and Anjan Thakor (1996). ‘How do You Win the Capital Allocation Game?’, IFA
Working Paper, 234.
(^7) Sharpe, Paul and Tom Keelin (1998). ‘Smithkline Beecham Makes Better Resource–Allocation Decisions’, Harvard
Business Review, Mar–Apr.