1 SUPERVISOR: PROF. E.C. OSUALA - University of Nigeria...SUPERVISOR: PROF. E.C. OSUALA MARCH, 2011...
Transcript of 1 SUPERVISOR: PROF. E.C. OSUALA - University of Nigeria...SUPERVISOR: PROF. E.C. OSUALA MARCH, 2011...
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UTILIZATION OF CAPITAL BUDGETING AS AN OPTIMAL TOOL FOR
INVESTMENT ANALYSIS IN MANUFACTURING COMPANIES IN ENUGU
AND ANAMBRA STATES
BY
AGBOH, CALLISTUS IK
PG/Ph.D/06/42140
A THESIS SUBMITTED TO THE
FACULTY OF EDUCATION, UNIVERSITY OF NIGERIA, NSUKKA
IN PARTIAL FULFILLMENT FOR THE AWARD OF THE DEGREE OF
DOCTOR OF PHILOSOPHY (Ph.D) IN BUSINESS EDUCATION
SUPERVISOR: PROF. E.C. OSUALA
MARCH, 2011
CHAPTER ONE
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INTRODUCTION
Background of the Study
A company is a form of business organization, a corporate body or a
corporation, generally registered under the company‟s Act or similar legislations. It is
a legal entity, created under an enabling law of the government, having unlimited life
span and limited liability. Igben (2007) defines a company as a body corporate,
having a distinct legal personality created by or under an enabling statute of the
government. A company is a form of business organization, whose characteristics
include; limited liability, corporate body, right to sue or be sued, enter into contracts,
owe debts, pay debts, pay taxes, pay dividend from earnings, and neither the death nor
the bankruptcy of any of its members can force it to liquidate (Chartered Institute of
Management Accountants (CIMA), 2004).
Manufacturing companies are companies that convert raw materials and
component parts into consumer, and or industrial goods (Garner, 2001).
Manufacturing companies are companies that engage in production (i.e. business
organizations which creates utility). The manufacturing sub-sector can be classified
based on two major sub-division; either in accordance with area of coverage, or in
relation to its capital base. Based on area of coverage, four distinct groups are
identified, namely: the multi-nationals, the nationals, the regional and the local
manufacturing companies. Based on size of capital, four companies can be identified,
namely: the micro cottage, the small scale, the medium scale, and the large scale
manufacturing companies. However, manufacturing companies as is used in this
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work refers essentially to companies that engage in productive activities and whose
liability is limited, irrespective of size or area of coverage.
Micro-Cottage companies are those which have a total capital employed of not
more than N1.5 million excluding cost of land and, or a workforce of not more than
10 persons. Small Scale companies have over N1.5 million but not more than N50
million excluding cost of land and, or 11 – 100 workers. The medium scale has over
N50 million but not more than N200 million, excluding cost of land and, or 101 – 300
workers. Any company that has a capital of more than N200 million, excluding cost
of land and, or more than 300 workers in its employ is classified large scale (National
Council on Industry (NCI) 2004, in Eneh, 2005).
According to Eneh (2005) the large sums of capital involved in siting
companies in the Urban areas had often made the growing manufacturing companies
to be located in the suburb and rural areas. Urban areas Eneh referred to as places
with many huge concrete buildings, shops, places of work, entertainment, worship
centers, and with large concentration of people industries and social amenities. While
rural areas are countryside which lack in some of these amenities and are under-
developed. Other reasons for siting manufacturing companies in the rural areas which
may affect capital budget include: government tax benefits, cheaper land, cheaper
manpower, and nearness to raw material deposits.
The manufacturing sector has grown much in size that its level of intensity has
become an acceptable index for measuring the economic prosperity of any nation
(Okafor, 1983). High level of productive activities gives rise to abundance of
consumer goods and services, thus facilitating improvement in the productive
efficiency of the factor inputs. The factor inputs comprises of the primary factors
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(land, labour and other natural resources); and secondary or produced factor inputs of
money, machine and other man-made resources. These produced factor inputs
according to Sadler (2003), are otherwise referred to as capital.
Capital consists of assets, monetary and non monetary, contributed by owners
of a corporate organization to keep a business afloat. Association of Certified
Chartered Accountants (ACCA) (1998) defined capital as the monetary and non
monetary assets contributed by the owners of an enterprise (equity capital) and by the
creditors (loan capital) to get the organization going. It refers to the right of a
company to utilize the services of produced factor inputs. This right can be exercised
either in the ownership and control of real assets or in that of the financial assets.
Real assets are tangible assets, while financial assets are claims on income to be
generated by real assets. The total value of real and financial assets available to an
economic unit at any point in time constitutes its stock of capital (Gordon, 2004).
Capital is a discrete variable. It is not measured over a given period, rather at a given
or discrete time. As such, the design to increase, improve or maintain capital (i.e.
investment) has to be planned and returns predetermined. The predetermination of
investment returns before venturing into it keeps manufacturing companies on track,
in the choice of investment.
Investment refers to assets acquisition by company for the purposes of capital
appreciation and income generation (Nweze, 2004). It encompasses all economic
activities designed to increase, improve or maintain the productive quality of existing
stock of capital. When the stock of available capital falls below the quantity required
to achieve the desired levels of output, the need for additional investment arises
(Williams, 2008). Consequently, the desired stock of capital depends basically on
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two factors; viz: (i) the volume of output, and (ii) the amount of capital stock required
per unit of the output. It is the determination of this desired stock level of capital
coupled with its relative rates of return (cashflow) that makes budget an inevitable
tool for corporate existence.
A budget is a formal statement of a company‟s future plans which is usually
expressed in monetary terms. It is an investment analytical tool which aids financial
managers to make an informed managerial decision. The Chartered Institute of
Management Accountants (CIMA), 2004) defined budget as a plan quantified in
monetary terms, prepared and approved prior to a defined period of time, usually
showing a planned income to be generated, and or expenditure to be incurred during
that period, and the capital to be employed to attain a given objective. In essence, the
budget of a company cannot be prepared in isolation of the firm‟s financial status –
stock of capital.
Capital budgeting is the process of planning expenditure on assets whose
returns are expected to extend beyond one year. Institute of Chartered Accountants of
Nigeria (ICAN) (2006) described capital budgeting as a firm‟s decision to invest its
current funds most efficiently in long term assets in anticipation of an expected flow
of benefits over a series of years. The ability to take capital budgeting decisions
satisfactorily is dependent on the evaluation for proper use of capital budgeting
techniques employed for investment analysis. The reason is that, every investment
environment is usually surrounded by investment risks. Such risks include the „alpha‟
or non market imposed risks, and „beta‟ or the market imposed risks.
In other words, the effectiveness of capital budgeting as an investment tool for
optimal investment decision is dependent on the management‟s ability to functionally
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utilize the capital budgeting evaluation criteria to obviate or minimize investment
risks. Capital budgeting evaluation criteria is a combination of capital budgeting
techniques and the risk adjusted techniques. The capital budgeting techniques include
the discounted and the non discounted investment evaluation criteria, while the risk
adjusted techniques are management strategies adopted by companies to avert or
minimize investment risks. They include, the risk adjusted statistical techniques; the
conventional techniques of risk analysis; the scenario analysis; and the sensitivity
analysis.
In most companies, the finance unit constitutes a department, headed by the
finance director. In the capital budgeting section, the management staff that usually
constitute members are; the managing director, the finance manager, the internal
auditor and the purchasing manager. The managing director is often the president of
the firm and is responsible for all top level decisions including the introduction of
change into the organization. The finance manager who is usually the head of the
budgeting unit is responsible for obtaining and managing the company‟s fund. The
internal auditor monitors, evaluates and reports to management on the internal control
system of the company. While the purchasing manager takes charge of stock control
and management, both of goods and property (Surridge and Gillespie, 2008).
However, most small and medium scale companies, due to capital constraints
and cost implications of establishing a budget unit, utilize the services of an external
provider. In essence, manufacturing companies that were not viable enough to
establish a budget unit would require to outsource its capital budgeting decisions in
order to achieve efficiency. Outsourcing refers to the utilization of external resources,
the commission of the execution of tasks, function and processes as cannot be
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efficiently handled in-house to an external provider specializing in a given area
(Koszewska, 2004).
Effective capital budgeting presupposes adequate timing of assets acquisition
and rate of returns forecast. A manufacturing company which foresees the need to
procure capital assets in time has the opportunity to install the assets before its sales
are at capacity (Elijelly, 2004). Wrong forecast of capital assets‟ requirement
plunders companies into adverse business consequences that may be very difficult to
reverse. It can result in loss of company‟s market share to rivals, capacity
underutilization, poor earnings and losses.
To achieve effective capital budgeting, management has to be guided by the
company‟s corporate plan. Corporate planning entails establishing goals and suitable
courses of action for achieving such goals. Management in order to achieve effective
capital budgeting shall comply with the procedure established for such goal
attainment. Nwude (2001) elaborated on the typical procedure en-route effective
capital budgeting to include, establishing selection criteria; investigating proposals to
determine their value and feasibility; comparing alternative projects; determining the
financial needs, costs and resources; deciding on the projects to be implemented;
allocating funds to their development; and controlling and reviewing results. This
procedure otherwise referred to as capital budgeting decision process, is, according to
Pandy (2006), termed capital investment analysis.
Investment Analysis entails adequate knowledge of cost of sales, estimate of
yield, and formulation of optimal mix of securities to obtain higher yielding
portfolios. It involves the evaluation of an investment through the establishment of
cash flow, estimation of the required rate of return (the opportunity cost of capital)
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and the application of a decision rule for making the choice (Leloup, 1998). The
implication is that, the most accurate investment analysis and subsequent decision can
only be achieved in a predictable investment environment.
Nigerian investment environment is full of uncertainties that are often
responsible for investment failure. These uncertainties Eneh (2005) elaborated,
include: the uncertainty in the occurrence of future expectations caused by political
factors; the uncertainty of economic climate caused by interest rate fluctuations,
inflationary pressure, monetary and fiscal policy inconsistencies; uncertain social and
cultural factors caused by the mood and belief inconsistencies of the citizenry; and the
ever growing technological factors which affect the utilitarian purposes of capital
asset‟s procurement. These uncertainties pose threat and are danger signals to the
Nigerian manufacturers; hence they are potentials for their incessant failure.
Examples of moribund manufacturing companies in Enugu and Anambra states
include, Niger-Delta Floor Mill, Umunya; Anambra Machine Tools and Foundry,
Onitisha; Premier Breweries, Onitsha; Science Equipment Manufacturing Company,
Akwuke; Brick Manufacturing Company, Akegbe Ugwu; Anambra Vegetable Oil,
Nachi; Aluminum Product (ALPUM), Ohebe-Dim; to mention but a few.
In the South Eastern states, the Bureau for Public Enterprises noted that, most
manufacturing companies disappeared in the last two decades due to unpredictable
government policies, lack of basic raw materials (most of which are imported), high
interest rates, non implementation of protective existing policies, lack of effective
regulatory agencies, infrastructural inadequacies, unfair tariff and low patronage
(BPE, 2004). Despite these risk factors noted above, and uncertain investment
environment, Nzelibe (2000) contends that the prospects of Nigeria manufacturers are
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bright. According to him, giving the nation‟s nascent democracy, a market size of
140 million people, rich mineral and other resources, size of the West African market,
as well as cheap and abundant labour; the prospects of manufacturing in Nigeria are
bright.
Statement of the Problem
The manufacturing sub-sector in every economy serves as an engine for
economic development, yet the manufacturing sub-sector in Nigeria, and Enugu and
Anambra States in particular, has continued to decline in growth. This slow pace in
growth can be traced to the „risk averse‟ economic environment which has
discouraged diversification and expansion of local industries. The situation is further
complicated by the political, economic and socio-cultural inconsistencies (Eneh,
2000).
A recent survey conducted by Eneh (2005) showed that 97.6% of Nigeria‟s
industrial and manufacturing sub-sectors are made up of Micro Cottage, Small and
Medium Scale Enterprises (MSMSE‟s), and that three out of four of these firms fail
every year; while nine out of the ten prospective entrepreneurs did not venture into
the business. Similarly, Nzewi (2007) classified the state of the Nigerian
Manufacturing Companies as follows: 30% closed down; 60% ailing and 10%
operating at sustainable level. Nzewi furthered maintained that one of the major
constraints identified is the business environment – the enabling conditions in terms
of government policies, institutions, physical infrastructure, human resources and
administrative services, are lacking. Nigeria‟s manufacturing sub-sector witnessed a
12% growth in 1976, and its contribution to Gross Domestic Product rose from 4% in
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1973 to 13% in 1983; but turned a negative value of – 0.9% in 1999, from – 2.6% in
1994 (CBN Statistical Bulletin, 2001).
These rates of failures though may be partly blamed on the socio-political and
economic inconsistencies of Nigeria investment environment, the adequacy, extent of
use, and the efficiency of capital budgeting need to be ascertained. This is necessary
because of the materiality of capital budgeting decisions, which its efficient
application or otherwise, could determine the future prospect of the company. The
problems of predicting events with certainty in an uncertain economic environment;
the complex nature of capital budgeting application and method of computation; the
sophistication of the capital budgeting evaluation techniques and risk measurement
devices; and inadequate infrastructure and manpower, affect manufacturing
companies‟ effective operations. These problems also militate against efficient
utilization of capital budgeting for investment analysis in most manufacturing
companies. The mass failure of industries in the manufacturing sub-sector which is
presumed to have resulted from the improper use of capital budgeting for optimal
investment analysis by manufacturers in Enugu and Anambra States necessitated this
study.
Purpose of the Study
The major purpose of this study was to determine the extent to which capital
budgeting is being utilized as a tool for optimal investment analysis in manufacturing
companies in Enugu and Anambra states. Specifically, the study sought to:
1. ascertain the extent to which capital budgeting processes aided corporate
planning for long term survival of manufacturing companies,
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2. determine the extent of management‟s compliance to the use of capital
budgeting techniques for investment decisions,
3. determine the extent to which manufacturing companies utilize capital
budgeting investment evaluation criteria for investment decisions,
4. ascertain the extent to which outsourcing is utilized by manufacturing
companies in taking capital expenditure decisions,
5. determine the extent the use of capital budgeting techniques for investment
analysis enhance the earnings of manufacturing companies,
6. find out the constraints to effective use of capital budgeting for investment
analysis‟ and
7. determine the strategies for improving on the effective use of capital budgeting
for investment analysis in manufacturing companies.
Research Questions
The following research questions guided the study:
1. To what extent does the use of capital budgeting decision processes aid
corporate planning for long term survival of manufacturing companies?
2. What is the extent of management compliance to the use of capital budgeting
techniques for investment analysis?
3. To what extent does manufacturing companies utilize capital budgeting
investment evaluation criteria for investment decisions?
4. To what extent does manufacturing companies utilize outsourcing for capital
expenditure decisions?
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5. To what extent does the use of capital budgeting techniques for investment
analysis enhance the earnings of manufacturing companies?
6. What are the constraints to the effective use of capital budgeting for
investment analysis?
7. What are the strategies for improving on effective use of capital budgeting for
investment analysis?
Hypotheses
The study tested the following five null hypotheses at 0.05 level of
significance.
HO1: There is no significant difference between the mean responses of the
management staff from urban manufacturing companies and those from rural
manufacturing companies on the extent to which capital budgeting is utilized
for investment decisions in Enugu and Anambra states of Nigeria.
HO2: There is no significant difference among the mean responses of the managing
directors, the accountants, and the purchasing managers on management‟s
compliance in the use of capital budgeting techniques in manufacturing
companies.
HO3: There is no significant difference among the mean responses of the small,
medium, and the large scale manufacturing companies on the extent to which
outsourcing is utilized by manufacturing companies in taking capital
expenditure decisions.
HO4: There is no significant difference among the mean responses of the small,
medium, and the large scale manufacturing companies on the extent to which
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the use of capital budgeting techniques for investment analysis enhance
manufacturing company‟s earnings.
HO5: There is no significant difference between the mean responses of the
management staff from urban manufacturing companies and those from rural
manufacturing companies on the factors that constrain effective use of capital
budgeting for investment analysis.
Significance of the Study
The findings of this study would be of immense benefit to many people and
institutions in Enugu and Anambra states. Manufacturers would be made to
understand that investment decisions are long-term decisions where consumptions
and investment alternatives are balanced over time, in the hope that new investment
would generate extra returns in the future. They would also understand that capital
budgeting aid organizational efficiency and survival, irrespective of the risk factors
inherent in the business environment. Equally, they would appreciate that effective
use of capital budgeting strengthens corporate plan through timely and optimum
employment of capital for maximum returns. Management would be made to
understand that corporate planning enhance the predictive possibility of embarking on
a specific course of action with relative certainty of the outcome.
The findings of this study would assist the manufacturers, managers and
investors alike, in taking realistic investment decisions. Analysis of the investment
evaluation criteria, especially with regards to environmental risks, would enable
investors and managers minimize the errors of investing wrongly on capital assets.
The findings would sensitize manufacturers that wrong procurement of capital assets
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might lead to capital underutilization which could plunder a firm into adverse
business consequences. Specifically, both the management, and the financial
managers would be made to understand that investment decisions are more realistic
when taken based on strategic management information and capital budgeting
evaluation techniques.
The findings of this study would assist management and investors with
information on how to avert the dangers of adverse environmental variables through
the prediction of the present value of future investment and its relative rate of returns
overtime. Risks may not be fully adjusted using only capital budgeting techniques.
The findings of this study would enable manufacturers understand that, though the
difficulty in using risk adjusted techniques to compliment capital budgeting
techniques when evaluating investment decisions, expenditure decisions so reached
are usually stable and realistic.
The findings would assist management in choosing and allocating resources
to capital assets that would boost the profit base of the company. Efficient use of
outsourcing in execution of tasks and functions which cannot be effectively handled
in-house would reduce cost and boost manufacturing company‟s earning. The study
would highlight the strengths and weaknesses of outsourcing to facilitate
manufacturing companies‟ choice of when, how, what, and who to outsource.
The findings of this study would significantly be beneficial to researchers,
teachers and students of Accountancy and Accounting education in tertiary
institutions in Nigeria. It would aid researchers generate base information for their
research work, as well as aid further investigation on ways of improving on capital
budgeting to obviate the mass winding-up of manufacturing companies in Nigeria.
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The knowledge of the extent capital budgeting is utilized by manufacturing
companies for investment analysis would assist accounting educators improve on
their course content, curriculum and method of teaching. It would equally aid them
guide prospective investors and manufacturers on when and where to invest.
Curriculum planners of accounting education would use the facts of the findings in
curriculum planning and review. Students would be placed in the right frame of mind
to actualize their dreams of investing wisely, also being successfully employed as
financial analysts or in the least being self employed after graduation.
Finally, the knowledge that would be embodied in this study will aid policy
makers and public authorities responsible for the formulation of investment policies
and regulatory measures, make formidable policies and rules that would protect and
promote manufacturing companies to foster the economic development it is meant to
achieve.
Delimitation of the Study
This study was conducted in Enugu and Anambra states of Nigeria. It
covered the extent manufacturing companies‟ utilize capital budgeting for optimal
investment analysis. No attempt was made to include other manufacturing companies
in other states of the federation.
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CHAPTER TWO
REVIEW OF RELATED LITERATURE
The literature related to this study was discussed under the following headings:
Conceptual Framework
Company
Manufacturing
Manufacturing Company
Capital
Investment
Budget
Capital Budgeting
Investment Analysis
Utilization of Capital Budgeting for Investment Analysis
The need for capital budgeting decision processes in corporate planning
Management compliance in the use of capital budgeting techniques
Utilization of capital budgeting by manufacturing companies for
investment analysis
Outsourcing of capital expenditure decisions and the prospect of
manufacturing companies
The effect of utilization of capital budgeting on companies earnings
Constraints to effective use of capital budgeting for investment analysis
Strategies for improving on the use of effective capital budgeting
Theoretical Framework
Quantity Theory of Money
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Liquidity Premium Theory
Arbitrage Theory of Capital Assets Pricing
Utility Theory
Portfolio Investment Theory
Dominant Theory of Budgeting
Related Empirical Studies
Summary of Related Literature
Conceptual Framework
Company
A company is a form of business organization, a corporate body or a
corporation, generally registered under the company‟s Act or similar legislation.
Chartered Institute of Management Accountants (2004) defined a company as a legal
entity, an artificial person, that has rights and responsibilities of a real person, hence
very independent of its owners, and whose formation is either through the acts of
parliament or by the nations company‟s acts. It is a form of business organization
incorporated according to the relevant laws of the country in which it operate, having
unlimited life span and limited liability, which can sue or be sued, enter into contracts
and pay dividend.
In English law, and therefore in Commonwealth realms, a company is a form
of body corporate or corporation, generally registered under the companies Acts or
similar legislations. It does not include a partnership or any other unincorporated
group of persons; hence they are not formed by the Act of parliament or by legislation
under company law, referred to as a limited liability or joint stock company. In the
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United Kingdom, the main regulating laws are the Company‟s Act of 1985 and the
Company‟s Act of 2006. In Nigeria, references are made to the Company‟s
Ordinance of 1912, 1917, 1922 and 1948; which later metamorphosised to the
Company and Allied Matter Decree of 1968; now revised, and known as company
and Allied Matter Act of 1990.
Companies may be classified into two major groups, namely: the private
company, and the public company. Private company according to Anyaele (2003), is
a form of limited liability organization formed and owned by between two and fifty
shareholders, whose shares cannot be traded on publicly nor transferred without the
consent of other shareholders, and is not quoted or listed in the stock exchange
market. Section 2 of the Company and Allied Matters Act of 1990 classified as
public, a company which has limitless number of shareholders, whose shares are
traded publicly and quoted in the stock exchange, and which members transfer shares
at will. Public companies are companies whose shares can be publicly traded, often
(although not always) on a regulated stock exchange; while private companies do not
have publicly traded shares, and often contain restrictions on transfer of shares
(Garner,2001).
Manufacturing
Manufacturing refers to a range of human activities, from handicraft to high-
tech, but is most commonly applied to industrial production, in which raw materials
are transformed into finished goods on a large scale (Zhou, 1995). The term
manufacturing is coined out from the Latin word “manu-factura”, meaning „making
by hand‟. It is the use of tools and labour to make things which are utility bound, for
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use or sale. Zhou further stated that modern manufacturing includes all intermediate
processes required for the production and integration of a product‟s components.
This presupposes that manufacturing goes farther than transforming raw materials to
finished goods to include, processing of raw materials to semi finished (industrial)
goods for a second company‟s further processing. This later class of manufacturing is
according to Zhou referred to as “toll manufacturing”.
Manufacturing Company
Manufacturing company on the other hand are companies that converts raw
materials and component parts into consumer or industrial goods. They are
companies that engage in fabrication of semi finished goods and, or the direct
processing of raw materials to finished goods (Afolabi, 1999).
The manufacturing sub sector can be classified based on two major sub-
divisions; either in accordance with area of coverage, or in relation to its capital base.
Based on area of coverage, four distinct groups are identified, namely; the
multinationals, the nationals, the regional and the local manufacturing companies.
The multinational companies encompass all companies with international spread.
That is, company with branches in many countries of the world. The nationals are
classified as those that are based within a country; while regional and locally based
are those that have their branches, if any, located within a region and those which
may concentrate in the rural areas of a state (Graham and Harvey, 2001).
Based on size of capital, four distinct classes of manufacturing companies are
also identified and they include; the micro cottage, the small scale, the medium scale,
and the large scale manufacturing companies. The definition of each of these class of
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company varies from nation to nation and even authors, according to the number of
persons employed and the size of company‟s capital base.
In Nigeria, single skilled artisans carried out the earliest form of
manufacturing with assistants, and training was through apprenticeship (Eneh, 2000).
Though remarkable change may be assumed to have taken place following Nigerian
independence, the wrongly held views and misconceptions about Vocational and
Technical Education made for a minimal progress in entrenching work habits in the
beneficiaries. In fact, Vocational Technical Education beneficiaries who could have
created work (become manufacturers) seek employment.
Vocational Technical Education according to Osuala (2000) is that type of
education which promotes the dignity of labour by entrenching work as a goal of
education. One of the goals of Vocational Technical Education according to NPE
(2004) is, to give training and impact the necessary skills to individuals who shall be
self reliant economically. If manufacturing as is earlier defined entails range of
human activities (work), ranging from handicraft to high-tech, and VTE was fully
entrenched in the Nigeria school system since the 1980‟s, it may be presumed that
Nigeria has embraced early, a class of education that could have aid meaningful
progress in their manufacturing sub sector.
Nzelibe in Eneh (2005) posit that for most part of the last decade, the Nigeria
industrial and manufacturing sectors account for less than 10% of the nations Gross
Domestic Product (GDP), with manufacturing capacity utilization remaining below
30%. This contrasts what obtains in the developed economies whose manufacturing
sub sector according to Eneh accounts for over 70% of its gross national earnings.
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Wehmeier (2001) defined apprenticeship as a system where someone is
contracted out to serve a skilled person for a period of time, and often for low
payment, in order to learn that person‟s (master‟s) skill. It is the process of educating
the child on the skills of the master. In essence, the first known Nigeria
manufacturers are the porters, weavers, the blacksmith, painters, sculptors, carvers,
and even farmers; and skills were owned by families, hence are highly valued and
zealously protected (Banjo, 1974). Even with the introduction of Vocational
Technical Education during the post independence era, the uncheering image which
followed suit made people believe that only the less privileged should be given the
knowledge of trading, cooking, gardening, carpentry (vocational education), while
academically bright students should go into literal education to get acquainted with
how to administer and govern (gain knowledge for white collar job).
Fafunwa (1974:195) in support of the above view opined, “the voluntary
agencies who pioneered western education in Nigeria were unable to popularize
Vocational Technical Education because of cost of training the staff and equipping of
such schools”. Apart from the cost Fafunwa further stated, evidence abound that the
colonial lords were mainly concerned with offering the natives little liberal education
which will enable them become interpreters, hence aid them achieve their economic
and religious aim. As such, Vocational Education and Manufacturing in Nigeria
suffer till date.
The manufacturing sector in developed countries has grown in size that its
level of intensity has become an acceptable index for measuring the economic
prosperity of any nation (Okafor, 1983). High level of production activities give rise
to abundance of consumer goods and services, thus facilitates improvement in the
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production efficiency of the factor inputs, namely: the primary inputs (land, labour
and other resources); and the man made or produced factors. This produced factor
inputs are otherwise referred to as capital (Sadler, 2003).
Capital
Capital consists of assets, monetary and non monetary, contributed by owners
of a corporate organization to keep a business afloat. Association of Certificated and
Chartered Accountants (1998) defined capital as the monetary and non-monetary
assets contributed by owners of an enterprise (equity capital), and by the creditors
(loan capital) to get the organization going. It refers to the right of an enterprise to
utilize the services of produced factor inputs. In other words, capital (money) is held
because transactions take place at discrete time intervals.
However, the right of a company to utilize the services of produced factor
inputs (capital) is a function of the total value of real and financial assets available to
it (Govidarajan and Anthony, 2004). This right can be exercised either in the
ownership and control of real assets, or in that of financial assets. According to Pandy
(2006), real assets are tangible assets, while financial assets are claims on income to
be generated by real assets. Pandy further stated that, the total value of real and
financial assets available to an economic unit at any point in time constitutes its stock
of capital, otherwise referred to as, the wealth of that economic unit.
The objective for setting up manufacturing companies is wealth creation (Hirst
and Baxter, 1996), otherwise referred to as creation of utility (Samuelson, 1978).
Samuelson refer to utility as the ability of a product or service to satisfy human wants.
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Hirst and Baxter defined utility as, that added value which makes a product or service
to be more esteemed than it initially was. This Hanson (1976) sees as production.
Wealth on the other hand, refers to the totality of a company‟s earning
resulting from its investment (Lucy, 2003). As such, the design to increase, improve
or maintain capital (i.e. investment) has to be planned and returns predetermined,
hence every manufacturing company aims at wealth maximization. The wealth
maximization principle implies that the fundamental objective of a company is to
maximize the value of its shares (Pandy, 2006). The value of the company‟s shares is
represented by their market price, which in turn is a reflection of shareholders
perception about quality of the firm‟s financial position. Pandy maintained that, the
market price of shares serves as the company‟s performance indicator.
Investment
Nweze (2004) defined investment as assets acquisition by an enterprise for the
purposes of capital appreciation and income generation. It encompasses all economic
activities designed to increase, improve or maintain the productive quality of existing
stock of capital. When the stock of available capital is less than the stock of capital
required to achieve the desired level of output, the need for additional investment
arises (Arnold and Turley, 1996). Consequently, the desired stock of capital
according to Okafor (1983) depends basically on two factors, viz: (i) the volume of
output, and (ii) amount of capital stock required per unit of the output. Similarly,
Hampton (1986) opined, optimum level of investment is reached when a company‟s
capital stock available could maintain maximally, the volume of output demanded of
the company to meet its market share. This implies that, optimum investment reflects
24
the production point at which a company meets its desired capital stock level to
achieve the best rate of returns, more so when compared with that of competitors. It
is the determination of this desired stock level of capital coupled with its relative rates
of return that makes budget an inevitable tool for company‟s corporate existence.
Budgeting
Budget is defined as the quantitative analysis made prior to a defined period of
time of a policy to be pursued for the period, to attain a given objective (Hanson,
1987). Similarly, Bodernhorn (2002) defines budget as, financial plans that provide
the basis for directing and evaluating the performances of individuals and segments of
the organizations. According to CIMA (2004), a budget is a plan quantified in
monetary terms, prepared and approved prior to a defined period of time, usually
showing a planned income to be generated, and or expenditure to be incurred during
that period, and the capital to be employed to attain a given objective. A budget could
be deduced to mean, a quantitative statement of plan of action for a defined period of
time, which may include planned revenues, expenses, assets, liabilities, and cash
flows which provides a focus for an organization; hence aids co-ordination of
activities, allocation of resources, and direction of activities for control purposes.
It may be pertinent at this juncture to note that different classes of budget exist
though may be subsumed into what is referred to as the master budget. The master
budget is the total budget package for an organization (Nweze, 2004). It combines all
the individual budgets for each part of the organization and aggregates it into one
overall budget for the entire organization. It may be subdivided into two major types
of budget, namely; i) the operating budget and, ii) the financial budget. The operating
budget consists of two parts, the programme budget and the responsibility budget.
25
The programme budget sets plan for estimated revenues and costs of the major
programmes that a company plans to undertake during the year (Hartmann and
Vassen 2003). It helps to determine, whether so much could be spent on a particular
item; whether adequate funds are available; whether the future benefits are
commensurate to the fund being committed; and so forth. The responses to these
opinions enable management take formidable decision that will stand the taste of
time.
The responsibility budget on the other hand, sets forth plans for persons
responsible for carrying out a specific task, work or activity. It is an excellent control
device since it is a statement of the performance that is expected of each
responsibility centre manager, against which his actual performance can later be
compared (Nweze, 2004). Nweze further contended that, if the total cost in a
responsibility centre is expected to vary with changes in volume as is the case with
most production responsibility centres, the responsibility budget may be in the form
of a variable or flexible budget, and as such will show the planned behaviour of costs
at various value levels.
The financial budget focuses more on plans for sources and application of fund
of the company. The major classes of financial budget include, the proforma
statement, the cash budget, the sales budget, the purchases budget, the production
budget and the capital expenditure budget. The proforma budget statement may be
further classified into, the budget income statement and the balance sheet budget.
The budget income statement is an estimated income statement, which indicates the
company‟s planned profit and loss activities; while the balance sheet budget statement
is an estimated balance sheet, which gives the company an indication as to what its
26
balance sheet will look like in the future. It enables the company to make a judgment
in advance whether or not, its financial position will be suitable to meet its need;
particularly in the eyes of creditors (Nweze, 2004). The proforma statement budget
are generally less useful than other types of budgets because they do not have periodic
comparisons for variance analysis (Nweze, 2004; and Nolon, 2005).
Cash budget according to Nolon (2005) is an operating budget detailing the
planned cash receipts and payments. It represents the cash requirements of the
business during the budget period, hence makes certain that the business has
sufficient cash to meet its needs as and when they arise. Cash budget may be seen to
replicate receipt and payment account except that, while cash budget is futuristic,
receipt and payment account is historical. Cash budget are routinely prepared, while
receipt and payment accounts are conventionally prepared annually (Dam, 2005).
Sadler (2003) opined, the corner stone of successful marketing plan in a firm is
the measurement and forecasting of market demand. The key figure needed by every
company for successful operation is the sales forecast. Pike and Zanibbi (1996)
expressed the view that, effectiveness of budgetary control depends on the accuracy
of sales estimate. As such, sales budget is usually the starting point for budgeting
purposes, and is defined as an estimate of the revenue to be generated by the company
from its operations, as well as the focus of the much that is done within the company.
It is the sales value computed for individual products in units, in naria and in total for
the whole organization.
The purchase of direct materials is dependent on the levels of the beginning
inventory and the ending inventory. Hence, the units of materials to be purchased are
determined thus; budget usage plus desired ending inventory, less beginning
27
inventory. The result will equal purchases in units for the year, and the responsibility
area of the purchasing manager. It is the determination of the physical units of
material inventory, as well as the monetary value from the raw material usage budget
and from the stockholding policy that is referred to as purchases budget (Dam, 2005).
The production budget on the other hand according to Osisioma (1997), is a
statement of output expressed in tones, units or standard hours. He stated further that
production budget determines what is to be produced, when it is to be produced, and
how many are to be produced. It is generally prepared after the sales budget and the
total units to be produced, which is dependant on the planned sales and the expected
changes in inventory levels.
Investment Analysis
Manufacturing companies in order to serve Nigerian economic climate need to
develop and implement a well-conceived strategic plan for analyzing its capital
investment. Investment analysis entails adequate knowledge of cost of sales, estimate
of yield, and formulation of optimal mix of securities to obtain higher yielding
portfolios. According to Brounen and Kosdijk (2004), investment analysis involves
the evaluation of an investment through the establishment of cash flow, estimation of
the required rate of return (the opportunity cost of capital) and the application of a
decision rule for making choice. It is an appraisal technique whereby the need for the
decision is outlined and set in the context of the organization‟s strategy. All realistic
options are identified and the relative merits and drawbacks of each option are
analyzed, culminating in the identification of a preferred course of action. In essence,
every investment is x-rayed in terms of its objectives, set in accordance with the
28
identified need, and clearly defined to produce criteria against which options can be
judged and against which the success of the project can be evaluated.
Similarly, Pandy (1999) posit that, it is important that the objectives of
investment are not so narrowly defined more so when such investment is strategic to
the company‟s survival, as to prevent consideration of inappropriate range of options,
as loose as to generate unnecessary work. A plan is strategic when it is very detailed
for achieving success in situations as complex as war, politics, business, industry or
sports (Procter, 1996).
Capital Budgeting
Capital budgeting which is the main concentrate of this work is defined
according to ICAN (2006) as, the firm‟s decision to invest its current funds most
efficiently in long term activities in anticipation of an expected flow of the future
benefits over a series of years. It is the process of planning expenditure on assets
whose returns are expected to extend beyond one year. Pandy (2006) pointed out that
investment decisions of the firm on capital assets are commonly referred to as capital
budgeting, capital expenditure management, capital expenditure decisions, capital or
long term investment decision, or management of fixed assets. It is the planning,
evaluation, and selection of investment in fixed asset proposals, which involves a
huge current outlay of cash resources in return for an anticipated flow of future
benefits. Investment in fixed assets have a long gestation period, from conceptual and
procurement stage, to when it starts to yield some stream of cashflows. Such
investment should be capable of yielding a reasonable rate of return so that the
business could meet its financial obligations to providers of capital (financiers) and
29
pay dividend to shareholders, or in a nutshell, maximize the wealth base of the
company.
According to Hilton (2004:186) capital budgeting is, “the decision making
process by which firms evaluate the purchase of major fixed assets, including
budilings, machinery and equipment. It also covers decisions to acquire other firms
common stock or groups of assets that can be used to conduct an on going business”.
Capital budgeting as described here involves the formal planning process to invest the
company‟s capital in the procurement of fixed assets, or otherwise in the buying-up of
an existing business (company) or its fixed assets, purposefully to enhance the
viability of the investing company through enhanced business activities.
Warren and Fess (1996:76) defined capital budgeting as, „the process by which
management plans, evaluates and control capital expenditure decisions‟. They stated
further that it maximizes the profit base of a company when handled proficiently and
may lead to liquidation when neglected. The implication is that, the management and
control of capital budgeting to a very large extent determines the company‟s viability
and survival or otherwise, its failure.
According to Philippalys (2003), capital budgeting is concerned with the
allocation of firm‟s scarce financial resources among the available market
opportunities. The consideration of investment opportunities involves comparison of
expected future streams of earnings from a project with immediate and subsequent
streams of expenditure on it. This assertion presupposes that capital budgeting
consists of the planning and development of available capital for the purposes of
maximizing the long-term profitability of the company. In other words, the system of
capital budgeting is employed to evaluate expenditure decisions which involve
30
current outlays, but likely to produce benefits over a period of time longer than one
year. The benefits referred to, may be either in the form of increased revenue or
reduction in costs. In essence, capital expenditure decision includes in addition,
disposition, modification and replacement of fixed assets.
The basic features of capital budgeting according to Pandy (2006) include,
potentially large anticipated benefits; a relatively high degree of risk; and a relatively
long time period between initial outlay and anticipated returns. These features Pandy
further stated are of paramount importance in financial decision-making and as such,
care should be taken in making such decisions on account that,
Such decisions affect the profitability of the firm and also have much bearing
on the competitive position of the enterprise;
The future destiny of the company lies on capital budgeting decisions;
It has its effect over a long time span and inevitably affects the company‟s
future cost structure;
Capital investment decisions once made are not easily reversible without much
financial loss to the firm;
Capital investment involves huge cost and the majority of the firms have
scarce capital resources;
Over or under capacity should be in constant check as both results to waste;
and
Investment decision though taken by individual concerns is one of national
importance because it determines employment, economic activities and
economic growth.
The point worthy of note in these features and care as is elaborated is that a
company which carefully plan the allocation of its resources to capital assets,
evaluates available alternatives, ranks properly the alternatives; and then decides on
which best alternative to undertake using the available capital investment techniques,
31
will always stand competitive through increased sales, profit and dividend, and
ultimately increase the value of its share price.
Capital budgeting refers to the total processes of generating, evaluating,
selecting and following-up on capital expenditure alternatives. The company allocates
and budgets financial resources to new investment proposal. It is unlike investing in
stocks and bonds, where one is required to approach the securities market and based
on established forecast, invest. A company has to be proactive while investing in
capital assets since it has to take the very first step of planning for such asset
acquisition (Brigham and Weston, 1992). The authors further stated that, because the
company has to take the initial action (has to be proactive) in allocating or budgeting
financial resources to new investment proposal, it might be confronted with three
types of capital decisions. They include;
1. Accept or Reject Decision: The fundamental decision in capital budgeting is
to accept or reject a project proposal. This decision is often based on,
accepting proposals which yield a rate of return which is greater than a certain
required rate of return or cost of capital. By this application, all independent
projects are accepted. Independent projects are projects that do not compete
with one another in such a way that acceptance of one precludes the possibility
of the acceptance of another. This entails that all the independent projects that
satisfy the minimum investment criteria are implemented.
2. Mutually Exclusive Project Decision: Mutually exclusive projects are that
which compete with other projects in such a way that the acceptance of one
will exclude the acceptance of the other projects. Alternative projects are
mutually exclusive when each project is a perfect substitute of the other. It
32
may be noted that the mutually exclusive projects‟ decision are not
independent of accept/reject decision. Mutually exclusive project decisions
acquire significance when more than one proposal is acceptable under the
accept/reject decision. As such, it then implies that some techniques (capital
budgeting techniques) have to be used to determine the best one. The
acceptance of the best alternative automatically eliminates the other
alternatives.
3. Capital Rationing Decision: Capital rationing refers to a situation where the
firm is constrained for external, or self imposed reasons, to obtain necessary
funds to invest in all investment projects with positive Net Present Value
(NPV). In a situation where a company has unlimited funds, capital budgeting
becomes a very simple process since independent investment proposals
yielding a return greater than some predetermined levels are accepted. (P.283).
However, this is not the situation prevailing in most of the business firms of
the real world. Though a company may have fixed capital budget, a large number of
investment proposals always compete in these limited funds. The company allocates
funds to projects in a manner that maximizes its long run returns. In that sense,
capital rationing refers to a situation where the company has more acceptable
investments requiring a greater amount of finance than is available with the firm. It is
concerned with the selection of group of investment proposals acceptable under the
accept/reject decision; hence ranking of the investment project is required. In capital
rationing, projects can be ranked on the basis of some predetermined criterion such as
the rate of return. The project with the highest return is ranked first and other
33
acceptable projects are ranked thereafter based on projected returns (Van Horne,
1998).
Utilization of Capital Budgeting for Investment Analysis
From the foregoing discussions on capital budgeting and investment analysis,
one may invariably argue that before a company can start the production of goods and
services, it must make adequate arrangement for all the necessary facilitates. The
acquisition of such facilities involves an enormous outlay of the company‟s capital
funds and must be carefully selected. Capital budgeting decisions shall be rooted in
efficient and effective use of the company‟s fund in the acquisition of the required
fixed assets. Effective and efficient utilization of capital budgeting provides a buffer
that will allow any company make good her sales, control its market share, maximize
its wealth base, and thus remain competitive (Hartmann and Vassen, 2003).
Utilization means to put into effective use (Wehmeier, 2001), while effectiveness and
efficiency go together in the literature of organization (Ile, 1999). Ile (1999) asserts
that effectiveness refers to the extent to which output is in line with organizational
objectives, while efficiency discusses the relationship between resources consumed in
the process of generating effective output and the output so produced.
Similarly, the foregoing discussion infers that efficient and effective utilization
of capital budgeting will result to the production of the desired output level at
minimal cost. Predicated upon this assertion is that any company that utilizes capital
budgeting effectively and efficiently will minimize cost, thus maximize the wealth
base of the company and as such cannot get liquidated.
34
The history of industrial development and manufacturing in Nigeria according
to Nzelibe in Eneh (2005), is a classic illustration of how a nation could neglect a
vital sector through policy inconsistencies and distractions, attributable to the
discovery of oil. Eneh affirms that manufacturing companies in Nigeria have suffered
tremendous set back since the late 1970‟s due to the discovery of oil. The near total
neglect of agriculture has denied many manufacturers and industries their primary
source of raw materials. The Nigerian populace today seek non-existing white-collar
jobs and political positions, „cheap means of making it‟, rather than embracing
agriculture which in the past was the mainstay of Nigerian economy. This has
resulted to mass unemployment and continued winding up of the manufacturing
companies in Nigeria. In line with this view, the Bureau for Public Enterprise have
noted that, with the exception of the multinational operators in the manufacturing sub-
sector, that other manufacturing companies have disappeared in the last two decades
due to unpredictable government polices, lack of basic raw materials (most of which
are imported), high interest rates, non implementation of protective existing policies,
lack of effective regulatory agencies, infrastructural inadequacies, unfair tariff and
low patronage (BPE, 2004).
According to Adams (2003), the Nigeria manufacturing companies are facing
lots of challenges as they struggle with economic depression and high inflation,
resulting from the international monetary fund (IMF) and World Bank credit policies
which have ushered in such programmes as Structural Adjustment Programme (SAP)
of the past, and the recent privatization and commercialization policies and
programmes. These programmes were initiated to promote the liberalization of the
Nigerian domestic economy, operations efficiency and productivity; promote private
35
owned enterprises growth and development, promote economic growth, trade and
investment.
Ocampe (2003) defined liberalization as the act of providing maximum
opportunity for a world free market economy, an open political system in which all
nations would participate to operate a long set of order and conventions. Though it
may have been the contention of the Nigerian government that its economic
liberalization policies would nurture an open economy and minimize the hurdles the
manufacturing companies need to clear in order to obtain raw materials and inputs,
and other resources for productive activities, Adams (2003) opined, it has created an
unprecedented change in their business environment through increased competition
both in the domestic market and from imports into the country.
Globalization constitutes another major challenge to Nigerian manufacturer.
Kwanashie (1998) defined globalization as the systematic integration of autonomous
economies into a global system of production and distribution. Globalization
encompasses global financial market; growth inter-connectedness of the media,
information systems, telecommunications and labour market; and global and regional
trade agreement. It is the common use and management of all nation‟s resources, and
as such, involve intensified competition, increased focus on product quality and more
attention on research and development.
Since globalization involve intensified competition, increased focus on
product quality and demands more attention to research and development, one may
conclude that it poses even a greater threat to Nigerian manufacturers‟ prospect;
moreso as Nigerian investment environment is full of uncertainties. These
uncertainties Eneh (2000) elaborated to include, the uncertainty in the occurrence of
36
future expectations caused by political factors; the uncertainty of economic climate
caused by interest rate fluctuations, inflationary pressure, monetary and fiscal policy
inconsistencies; uncertain social and cultural factors caused by the mood and belief
inconsistencies of the citizenry; and the ever growing technological factors which
affect the utilitarian purpose of capital assets procurement. These economic and
environmental uncertainties as elaborated above, pose great threat and are danger
signals to the Nigerian manufacturers, hence are potential for their incessant failure.
According to Eneh (2005), the Nigerian industrial and manufacturing sector
which accounts for over 50% of Nigeria‟s GDP in the past, account for less than 10%
with manufacturing capacity utilization remaining below 35% for most part of the last
decade. Eneh further observed that 97.6% of Nigeria‟s industrial and manufacturing
sub-sector is made up of Micro-cottage, Small and Medium Scale Enterprises
(MSMSE‟s) and 3 out of 4 of these companies fails every year, while 9 out of the 10
persons who wished to go into business in Nigeria failed to do so. Nigerian
manufacturing sub-sector witnessed 12% growth in 1976, and its contribution to
Gross Domestic Product (GDP) rose from 4% in 1973 to 13% in 1983, but turned a
negative value of -0.9% in 1999, from -2.6% in 1994 (CBN Statistical Bulletin,
2001).
The Need for Capital Budgeting Decision Process in Corporate Planning
Businesses have limited resources, which serve their basis for operation.
These limited resources impose limits on the number, extent, and range of end results
each business sometimes sets out to achieve. Limitedness of resources has made
planning an inevitable tool for corporate existence in any company, and one of the
37
most essential tools of management (Koontz, and O‟Donnel, 1972). Koontz and
O‟Donnel further stated that, though other management functions are important,
planning is all embracing since the future survival or otherwise of every corporate
organization revolves around it.
Corporate planning entails the perception of immediate and past position of
the organization to enhance estimation of the future capabilities and reduction of
perceived uncertainties (Lee, 1991). It equips management with adequate information
about a company‟s position to enable them estimate the possibility of embarking on a
specific course of action and achieve the desired result. According to Trewartha and
Newport (1992), corporate planning is a process of establishing goals and suitable
courses of action for achieving these goals. Similarly, Akpala (1990) defined it as
that plan made by a corporate organization to decide, what is to be done and to what
end; who will do what at certain time; and how it will be accomplished. Corporate
planning encompasses courses of action (plans) made by a corporate organization to
select in advance for its functional areas, future possible courses of action from
among alternatives that will lead to the realization of the organization‟s set objectives.
Corporate Planning reorganizes decision making; envisages problems;
evaluates a range of information hence make use of relevant ones to develop a
suitable line of action which when adhered to, will lead to the attainment of the
organizational goal. Trewartha and Newport (1992:90) defined corporate planning as
“a process by which managers visualize and determine future actions that will lead to
the realization of desired objectives”. Thierauf, Klekempt, and Greeding (1971)
viewed corporate planning as the job of making things happen that would not
otherwise occur. Akpala (1990) defined corporate planning as an analytical process,
38
which encompasses an assessment of the future, the determination of desired
objectives in the context of the future, the development of alternative courses of
action to achieve such objectives, and the selection of course or courses of action
from amongst these competing alternatives. Though Akpala‟s definition may be taken
as the comprehensive acceptable definition of corporate planning, Sadler (2003)
stated that there is no general acceptable definition of corporate planning. He further
stated that a comprehensive definition of corporate planning must be judged from four
major points of view, viz: the basic generic nature of planning, which is the setting up
of organizational objectives/goals; the process, that is the development of alternative
courses of action to attain such goal; the philosophy, which goal; and the structure,
the functional areas (units and departments) that propels the achievement of the goal.
However, corporate planning may be seen to encompass deciding in advance,
what to do; how to do it; when to do it; where to do it; who is to do it; why such thing
should be done, and the extent of resources (capital) to employ to accomplish what
was agreed should be done. The employment of capital suggests the expectation of
returns. This expected return (financial forecast) serve as a yardstick for appraising
corporate plan at intervals, thus financial planning is seen as an integral part of
corporate planning (Nnamani, 2008).
Financial planning according to Lucy (1998) is a process of identifying a
firm‟s investments and financing needs, given its growth objectives. It is the process
of analyzing a firm‟s investment options and estimating the fund requirement and
deciding the sources of fund. Financial planning pre-empts company‟s growth
performance, investments, and requirements of funds during a given period of time,
and as such, helps financial managers to regulate flows (sources and application) of
39
fund. A financial plan may be prepared for a period of three to five years, and „a
comprehensive financial planning encompasses profit planning as well‟ (Welch,
2002:560). Profit planning is an important short-term tool of management‟s corporate
plan of intentions expressed in financial terms, for the operations of the firm for a
short period (Lucy, 2003). It is a plan of the company‟s expectations, hence used as a
basis for measuring and controlling the actual performance of managers and their
units. This plan is seen as successful if goals to be attained are clearly stated with
proper assignment of authority and responsibility, and if it has top management
support (Matz and Usry, 1996). It could be deduced that a financial plan in itself is
meaningless if it did not encompass who does what, backed up with power/authority
and resources (capital).
On the other hand, a profit plan or budget could be divided into three parts,
operating budget, financial budget and capital budget (Horrigan, 1996). Operating
budget provides details about a company‟s operations, i.e. production, sales and
purchases budget. Financial budget focuses profit and loss statement and balance
sheet; statement of changes in financial position and cash budget. While capital
budget provide details of investment projects with the amount of capital expenditures
as is planned by the company. Among these three sub-divisions of budget, capital
budgeting decision is the most emphasized as according to Lucy (2003), a good
capital budgeting decision can boost earnings sharply and increase the prices of the
firm‟s stock, but a bad decision leads to bankruptcy. Lucy further stated that, because
of the materiality of the amount involved in capital investment decisions, one must
necessarily look before leaping. The implication of these statements is that, the major
yardstick for measuring corporate planning decisions which is the attainment of the
40
organization‟s goal is dependent on the effectiveness and efficiency of the company‟s
capital budgeting.
The above view can be substantiated citing Eugene (1995:20) on Lockheed‟s
production of L – 1011 Tri-Star Commercial Jet. He stated that,
Lockheed a classic transport company with a market
share value of $73 decided at its corporate meeting to
embark on the production of L-1011 Tri-star commercial
Jet. Part of the analysis that led to this decision was the
estimation of the Break-Even Volume (BEV) at about 200
commercial Jets. The company ordered for the parts
that will enable it conclude the production of 180 Jets
and was sure of getting at least 20 more orders.
Consequently it decides to commit $1 billion to
commence production. However, Lockheed company
analysis was flawed as it failed in its proper use of
investment appraisal techniques rather decides to go into
production with the believe that their capital could carry
the BEV. It was when the production had started with
the commitment of $1 billion and on further analysis that
Lockheed discovered that the BEV was far above 200
planes. So far the Tri-star Jet production was doomed
and the mistake made Lockheed’s stock value to decline
from $73 per share to $3.
This mistake, if not well managed may put the company out of the market and
eventually force it to liquidate. Erroneous forecast of assets requirement (capital
budgeting) poses serious consequences to company‟s survival; when effective capital
budgeting can improve not only the timing of asset acquisition but also increase the
quality of assets purchased (ICAN 2006). A company which forecasts its need for
capital assets in advanced will have an opportunity to purchase and install the assets
before they are needed. However, Lucy (2003) stated that many companies do not
order capital assets until they approach full capacity or are forced to replace worn out
equipment. This according to him has caused stunned growth in companies with
41
myopic capital budgeting decisions as they end up misusing unforeseen market
opportunities. Take for instance, if there is an unforeseen general increase in the sale
of the goods of a particular industry. Every company in such industry will want to
increase its capacity at the same time, hence will tend to order for capital assets at
about the same time. This general order will not only increase the price of such
capital asset, but such orders may equally be delayed. In essence, a company that
forecasts its need and purchased the asset or assets early, can readily increase capacity
and mop up the profit before others could obtain and install the assets that will enable
it increase capacity.
The significance of capital expenditure decisions cannot be overemphasized
hence has become frequent, repetitive, and time-taking in all business enterprise
(Elijelly, 2004). The quest for a viable capital expenditure decision has stimulated the
21st century companies to continually search for new ways to encourage growth,
improve financial performance, and reduce risk in the challenging economic climate
of today. This is because, funds tied up in capital assets often are dormant, when it
can be effectively used to finance growth strategies which will stimulate capital
expansion. The search to improve the financial performance of companies had
resulted to the development of investment decision model. That is, a patterned model
for decision-making which is adopted to checkmate wastages (both of time and cash)
that had always resulted in choosing a capital asset with the use of investment
analytical technique alone.
Dugdale and Jones (1995) affirmed, companies would benefit immensely in
terms of improved quality of decision-making if capital budgeting decisions are taken
in the context of its overall corporate strategy. This approach provides the decision
42
maker with a central theme, a model or a big picture to keep in mind at all times and
as guideline for effective allocation of corporate financial resources, Dugdale and
Jones further stated. In line with the above view, Nolon (2005) opined, allocating
resources to investments without a sound concept of divisional and corporate strategy
is a lot like throwing darts in a dark room. Similarly, Hastie (1984:196) argued as
follows:
We have erred too long by exaggerating the
‘improvement in decision making’ that might result from
the adoption of DCF or other refined evaluation
techniques. What is needed are approximate answers to
the precise problems rather than precise answers to the
approximate problems. There is little value in refining
an analysis that does not consider the most appropriate
alternative and does not utilize sound assumptions.
Management should spend its time in improving the
quality of assumptions, assuming that all the strategic
questions have been asked, rather than implementing
and using more refined evaluative techniques.
One of the major emphasis of Hastie‟s argument is that, though capital
budgeting evaluative techniques are important, its sole use in deciding the capital
expenditure to undertake may be unreasonable and counter productive. As such, the
strategic consideration of management in capital expenditure planning and control is
of immense importance. This strategic consideration Hastie referred to as, decision-
making process, while he sees the structure or framework as the decision model.
According to Hastie, strategic consideration is a systematic approach with which a
company who is properly positioned in a complex business environment balances its
multiple objectives through a systematic decision process. However, a
comprehensive capital expenditure planning and control system will not simply focus
on profitability, but also on growth, competition, balance of products, total risk
43
diversification, and managerial capacity and flexibility. One major way of balancing
capital budgeting evaluative techniques with the management corporate strategy to
generate efficient capital budgeting decision is by applying a formidable model.
According to Garrison and Noreen (2000), a major attribute of any model is that it
offers a structured discipline. This discipline helps to prevent the company and its
management from getting sidetracked from the major goal in contention. While the
structure is the representation of the physical steps to adopt enroute capital
expenditure decision which is referred to as capital expenditure decision model.
Capital expenditure decision model is an eight step budgetary process, which
is purported, should fit into an overall framework of capital budget planning,
decision-making and control (Hastie, 1984). Johnson and Kaplan (2001) see it as the
framework used to illustrate the stages involved in establishing a formidable capital
budgeting decision. It streamlines the stages and possible responsibilities of the
management in the decision-making process and control.
44
Figure 1: A decision making process for capital investment decision
Adapted: Dam C.V. (2005:207); Trends in Financial Decision Making, Planning
and Capital Investment Decision.
The first stage in the decision model is the identification of the company‟s
objective. In all, the company‟s employees must have a good understanding of what
the company is set to achieve. Strategic or long range planning therefore begins with
the specification of the objective towards which future operations should be directed.
The attainment of objectives should be measurable in some ways and motivate
people. Johnson and Kaplan (2001) distinguished between three different types of
objectives which form a hierarchy: the mission of the company, the company‟s
1. Identity Objectives
2. Search for Investment Opportunities
3. Identity States of Nature
4. List of Possible Outcome
5. Measure Payoffs
6. Select Investment Projects
7. Obtain Authorisation and Implement
Project
8. Review Capital Investment Decision
45
corporate objectives, and the unit objectives. The mission describes in general terms
the broad purpose and reason for the company‟s existence; the nature of the business
or businesses the company is/are into, and the customers it seeks to serve and satisfy.
It is a visionary projection of the central and overriding concepts on which the
organization is based (Hartman and Vassen, 2003). The company‟s corporate
objective on the other hand relates to the company as a whole but in measurable
terms. They are the company‟s set goal expressed in financial terms, such as; desired
profits or sales levels, returns on capital employed, and extent of growth or rate of
market share and so forth. While the company‟s unit objective relates to the specific
objective of individual units within the company; such as a division, department or
one plant within a holding company.
Search for investment opportunities serves the second stage of the decision
model for capital investment decision. The search for investment opportunities is a
fieldwork. The management at this stage proceeds in search for new investment
opportunities that even the most sophisticated evaluation techniques cannot identify.
A company‟s prospect depends more on its ability to create investments rather than
on its ability to appraise them (Dam, 2005). Thus, it is important that a company
scans the environment for potential opportunities or takes action to protect itself
against potential threats.
The third stage in the decision process is to gather data about the possible
future environments (states of nature), that may affect the outcomes of the projects.
Examples of possible states of nature include, economic boom, high inflation,
recession, policy change, and so on. These states of nature often cannot be predicted
46
with certainty. In essence, the examination of the past and current, and estimation of
future environmental dynamics are crucial to every investment decision.
After the states of nature have been identified, the fourth and fifth stages are to
list the possible outcomes for each state of nature, and measure the payoff of each
possible outcome in terms of the objective of maximizing the shareholders‟ wealth. It
is possible in the fifth stage that investment analytical techniques are employed. At
stage six, the project to be embarked upon is selected based on the results of stages
one to five, whichever investment alternative that satisfies the conditions of stages
one to five is selected in stage six, and passed on to the top management for
authorization and implementation under stage seven. It should be noted however, that
a project is selected and included in the company‟s long term plan does not
necessarily mean that authorization has been given to implement such project. It may
not be feasible in practice to specify standard administrative procedure for approving
investment proposals, as screening and selection procedures may differ from one
company to another. When large sum of capital expenditures are involved, the
authority for the final approval may rest with top management. The approval
authority may be delegated for certain types of investment projects. According to
Dam, though delegation may be affected subject to the amount of outlay, any delegate
should screen carefully the investment proposal before approval is given, as he will
always be held accountable for results.
The last stage in the capital expenditure decision model is the review of the
capital investment decision as implemented. Top management should ensure that
funds are spent in accordance with appropriations made in the capital budget. A
capital investment reporting system is required to review and monitor the
47
performance of investment projects both after completion, and during their life (Pike,
1992). The follow-up comparison of the actual performance with original estimates
not only ensures better forecasting, but also helps to sharpen the techniques for
improving future forecasts, Pike further stated. Based on the follow-up feedback
during the review exercise of stage eight, the company may re-appraise its projects
and take remedial action.
The arrow lines linking the various stages in the process represent feedback
loops. They signify that the process is continuous and dynamic. In order words, the
company‟s decision may change at the various stages and the process reverted to start
afresh, either from the beginning, or from whichever stage the management decides.
Graham and Harvey (2001) summarized the need for capital budgeting in
corporate planning to include:
1. Influence on the company‟s growth in the long run: a company‟s decision to
invest in long-term assets has a decisive influence on the rate and direction of
its growth. A wrong decision can prove disastrous for the continued survival
of the company while unwanted or unprofitable expansion of assets will result
in heavy operating costs to the company. On the other hand, in-adequate
investment in assets would make it difficult for the company to compete
successfully and maintain its market share.
2. Affect the risk complexity of the company: long commitment of funds may
change the risk complexity of the company. If the adoption of an investment
decision increases average gain but causes frequent fluctuations in its earnings,
the firm will become more risky. Thus, investment decisions shape the basic
character of a company.
48
3. Funding: capital budgeting decisions make it imperative for the company to
plan its investment programmes very carefully, and make an advance
arrangement for procuring finances internally or externally.
4. Irreversibility, or reversible at substantial loss: the company is made aware of
the irreversible nature of investment decisions as a prelude to being careful in
taking such decisions. Investment decisions are irreversible as it is difficult to
find a market for such capital items once they have been acquired.
5. They are among the most difficult decision to make: companies are made
aware of the complexity of assessing future events, which are difficult to
predict. It educates the company of the economic, political, social and
technological forces, which cause uncertainty in cash flow estimation. With
this fore warning, adequate care is taken both in the selection and use of the
Investment Appraisal Techniques; hence forecast is made with more precision.
The entire process of capital budgeting requires the commitment of a great
deal of the company‟s resources and as such its success or otherwise hinges on the
management‟s corporate planning and decision. Management therefore, in setting the
company‟s objectives which relate to capital budgeting, should seek to achieve
efficiency.
Management Compliance in the Use of Capital Budgeting Techniques
The complexity of capital expenditure decisions narrows the role of financial
managers in analyzing investment decisions in process. Financial managers in taking
capital expenditure decisions, more often, are unable to examine such variables like
marketing and strategic issues that may be difficult to quantify but are key decision
49
determinants to management (Barwise, et al., 1998). This they further stated has
made management compliance in the use of capital budgeting techniques often
difficult. Management often sees capital budgeting techniques as complex and
unreliable forecast that is based on mere assumptions of investment cash flows.
Hence, sees strategic investment decisions as should be better taken, after due
consideration of strategic issues like markets, products, technology and competition
(Car and Tomkings, 1996).
Nixon (1995) blamed the failure of management‟s compliance in the use of
capital budgeting techniques on the complex nature of its application and methods of
computation. He further argued that non of the capital budgeting techniques is
without some short comings, yet a decision has to be taken on when and how much to
be spent on each capital facility. This is irrespective of the social, political and
economic inconsistencies, which may further, increase the risk probability of each of
the techniques.
Ansari and Euske (2002) and Nwude (2001) argued that, it is really an onerous
task to correctly assess the future events which are difficult to predict, morose in an
investment environment with very high rate of uncertainty factors. This may be
blamed on why many investors in the developing countries base more on strategic and
historical marketing issues (trial and error decision making process), rather than on
established investment evaluation criteria in taking their investment decisions.
Management‟s non compliance with the use of financial appraisal techniques
such as ROI (return on investment) or DCF (discounted cash flow) may be blamed on
its failure to incorporate qualitative and strategic parameters that may favour
investments with long term benefits for the organization. Strategic management
50
information more often are not produced by accountants, but can come from
operational staff (marketing, sales, production and purchasing managers) as well.
This kind of information, the financial managers (Accountants) see as informal,
unstructured and „soft‟, thus are often reluctant to produce or use it (Klammer, 1992).
Though these contradictions, it may be contended that non of the decision
making process should rely solely on a line of information, hence both strategic issues
(strategic management information) and the capital budgeting evaluation criteria
(financial management information) should complement each other in taking realistic
and effective capital budgeting decisions.
Elijelly (2004) opined that the complex nature of decision making today has
made for the evolvement of an, Decision Analytical Hierarchy known as the Multiple
Attribute Decision Model (MADM) in financial management. This decision model
according to him is a decision „tree‟ which breaks down a complex decision into
component parts, which
a. Systematically considers both financial and non-financial criteria.
b. Judgements and assumptions are included within the decision based on
expected values;
c. Focuses more attention on those parts of the decision that are important; and
d. Include the options and ideas of others into the decision (group or team
decision making is usually much better than one person analyzing the
decision).
There are three major stages within the capital budgeting analysis using the
decision tree and they include,
i. Decision analysis for knowledge, building on essence, though the use of
capital budgeting;
ii. Option pricing to establish position; and
51
iii. Discounted Cash Flow (DCF) for making the investment decision.
In essence, though the use of Capital Budgeting Techniques in selecting
investment choice is prime, the first real step in capital budgeting decision should be
to obtain knowledge about the project, and organize this knowledge into a decision
tree. The advantages of using the decision tree Eidleman (1993) summarizes to
include: the reduction of project‟s uncertainty by obtaining knowledge; and the
making of realistic investment decision as all options or choices would be evaluated
and ranked through the use of DCF.
Often the use of capital budgeting techniques in taking capital investment
decision authenticates decisions about when, and how much to spend on capital assets
(Car and Tomking, 1996; Nwude, 2001; Gordon, 2004; Nweze, 2004 and Pandy,
1998); hence capital expenditure decisions taken without careful appraisal can cost
the organization it‟s existence. To avert the predictive uncertainty of capital
budgeting decisions using the investment appraisal techniques, several investment
appraisal techniques have to be applied. The ranking and selection of capital
expenditure using several appraisal techniques tantamounts to careful selection of
investment on assets. A carefully selected fixed asset (capital expenditure) is crucial
to the increase of the company‟s value and subsequently, the maximization of the
shareholder‟s wealth base (Gordon, 2004). Gordon equally advocated the strict
adherence to the following three steps in the ranking and selection of capital assets
that must maximize shareholder‟s wealth, base. They include,
1. Estimation of cash flow;
2. Estimation of the required rate of return (the opportunity cost of capital); and
3. Application of a decision rule for making the choice.
52
The implication is that a sound appraisal technique, should involve these three
evaluation criteria to be able to measure the economic worth of an investment.
However, Van-Horne (1998) argued that investments should be evaluated on the basis
of the criterion that is compatible with the objective of the shareholders wealth
maximization. In essence, the essential property of a sound appraisal technique is the
maximization of shareholder‟s wealth. Other characteristics according to Van-Horne
include:
1. it should consider all cash flows to determine the true profitability of the
project;
2. it should provide for an objective and unambiguous way of separating good
projects from bad projects;
3. it should help ranking of projects according to their true profitability;
4. it should recognize the fact that bigger cashflows are preferable to smaller
ones, and that early cashflows are preferable to later ones;
5. it should help to choose among mutually exclusive projects, that which
maximizes the shareholders wealth; and
6. it should be a criterion which is applicable to any conceivable investment
project independent of others.
Investment project, for the purposes of sound judgment, could be classified
into three. They include the mutually exclusive investments; the independent
investments; and the contingent investments (Quirin, 1977). The mutually exclusive
investments are that which serve the same purpose and compete with each other.
That means, if one investment is chosen, others in the same mutual class will have to
53
be excluded/disregarded. Investments are seen as independent when they serve
different purposes and do not compete with each other. Hence, the company‟s
profitability and availability of fund together with the speculated returns determine
the extent, and number of investments to undertake. While contingent investments
are dependent or complement projects in which the choice of one investment
necessitates the undertaking of the other or others.
A good number of capital budgeting techniques (investment evaluation
criteria) are in use in practice. This Pandy (2006:143) grouped in the following two
categories: a. The Discounted Cash Flow (DCF) criteria comprising of the Net
Present Value (NPV), the Internal Rate of Return (IRR), and the Profitability Index
(PI); and b. The Non Discounted Cash Flow criteria made up of the Pay Back Period
(PB), the Discounted Pay Back Period (DPBP), and the Accounting Rate of Return
(ARR). This non discounted rate of return is otherwise referred to as the traditional
investment techniques (Lucy, 2003, Elijelly, 2004; Nweze, 2004). Though these
authors classified the traditional investment appraisal techniques into two, the PBP
and the ARR; Pandy (2006) opined that a modified PB, (the DPBP) has been
developed to take care of time value of money.
A. The Discounted Cash Flow (DCF)
The DCF according to Nweze (2004) is a new investment evaluation approach
developed to take care of the timing of cash flow which the traditional techniques
ignore. Nweze defined DCF as a cash flow summary that has been adjusted to reflect
the time value of money. According to Elijelly (2004), it is an investment evaluation
technique, which takes a future amount and finds its value today. Unlike financial
accounting which uses historical values, financial management is concerned with the
54
values of assets today (present value); since the capital assets provide benefits into the
future, and since the Present Values (PV‟s) of the capital assets will be determined, its
cash flows will be discounted to the present.
DCF according to Govindarajan and Anthony (2003) are classic economic
models for measuring the profitability of investment projects, in which case the time
value of money is recognized. The major characteristic of the DCF methods is that
they consider the time value of money through the application of present value
analysis on a discounted basis. Discounting refers to taking a future amount and
finding its value today. Almost every manager trained in finance will ask for cash
flows on a discounted and non-discounted basis to reach a realistic investment
decision. DCF is often a better evaluation criteria as it makes use of the present value
concept; the idea that money you have today/now should be valued more than an
identical amount you would receive in the future. The money you have now, you
could in principle, invest now and gain returns or interest between now and the future
time. Money you will not have until some future time cannot be used now. Therefore,
the future of money‟s value is discounted in financial management to reflect its lesser
value (Brounen and Kosdijk, 2004). That is, discounted to worth its value at present,
otherwise referred to as Present Value (PV).
Other factors that necessitates the reflection of time value of money include,
inflation; which reduces value over time (N100 today will have less value in a year
period from now), uncertainty in the future; environmental inconsistencies that may
mar future expectation of returns (one may think he will make N200 five years from
now, but an unforeseen circumstance can differ, lessen or cause non receipt of such
amount at all), and opportunity cost of money; investing the money we have on hand
55
in alternative projects with higher returns adds more value to the money we have on
hand today.
The future worth of money today is called its present value, and what it will be
worth when it finally arrives in the future is called its future value. How much present
value should be discounted from future value is determined by two things, viz: the
amount of time between now and future payment, and the interest or hurdle rate;
noting that the interest rate is usually seen as the opportunity cost of capital (that is
the returns expected of the same amount when invested in alternative project with the
same amount of risk).
However, Present Value = (Future Value) ÷ (1 + Interest Rate); or
algebraically stated, PV = FV/1 + r. As such, the present value of N1000 one will not
have for a full year at 12% will equal,
PV = N1000 ÷ (1 + 0.12)
PV = N1000 ÷ 1.12 = N893
This means that, the worth of N1000 which will be received after one year, assuming
the opportunity cost of capital is 12% = N893.
Note that the formula changes to PV = FV ÷ (1 + 1)n, if the (time period)
number of years involved will exceed one year. The exponent „n‟ is simply the
number of periods, or years such investment is expected to last. In essence, the
present value of N1000 to be received in 4 years at 12% interest rate will equal, PV =
N1000 ÷ (1 + 0.12)4
= N1000 ÷ (1 + 12)4
= N1000 ÷ 1.574
= N635
56
It may be noted here that as payments gets further into the future, its present
value drops. Also, increasing the interest rate would further reduce the present value
{N1000 ÷ (1.20)4 = N1000 ÷ 2.07 = N483}. Eidleman (1993) suggests that, interest
rates were assumed to be zero in an economy with no investment possibility and zero
inflation (if there is any), making the present value always equal future value. Note
that PV can equally be computed by referring to PV tables. Generally, there are three
major economic criteria for evaluating capital assets, or projects under the DCF.
They include, the NPV; the IRR and the PI.
i. The Net Present Value (NPV) Method
Hilton (2004) defined NPV as the difference between the present value of the
cash inflows and those of the cash outflows, all discounted at the cost of capital.
According to Okafor (1983:222), „the NPV of a project is the present value of the
discounted net proceeds anticipated throughout the economic life of the project‟.
Pandy (2006:145) opined, NPV is classic economic method of evaluating investment
proposal and which correctly postulate that, „cashflows arising at different time
periods differ in value and are comparable only when their equivalents (present
values) are found out‟.
The procedure for obtaining the NPV of an investment according to Nwude
(2001:288) is as follows:
1. Ascertain the expected initial cost of the investment (ICo);
2. Ascertain the expected life of the investment (n);
3. Ascertain the annual cash flows from the investment;
4. Ascertain the cost of capital (i.e. the interest rate on funds used to finance the
investment);
57
5. With the cost of capital and the expected life of the project, find the interest
factors using the calculator or the PVF table;
6. Multiply the interest factors and the cashflows of the corresponding years to
get the respective present values of the amount of cashflows;
7. Sum up the present values of the yearly cashflows to get the investment total
present value;
8. From the total present value, subtract the initial cost of the investment. Then
the value you obtain is the NPV.
In line with the above view, Hilton (2004) outlined four steps involved in the
appropriate calculation of NPV. They include:
1. Cashflows of the investment project should be forecasted based on realistic
assumptions;
2. Appropriate discount rate should be identified to discount the forecasted
cashflows. The appropriate discount rate is the investment‟s opportunity cost
of capital, which is equal to the required rate of return expected by investors
on investments of equivalent risk;
3. Present value of cash flows should be calculated using the opportunity cost of
capital as the discount rate.
4. Net present value should be found out by subtracting present value of cash
outflows from present value of cash inflows. The investment should be
accepted if NPV is positive (i.e., NPV > 0)
Mathematically, NPV is obtained thus:
NPV = on
n
3
3
2
21 C - K) (1
C ...
k) (1
C
K) (1
C
k) (1
C
58
Therefore, NPV = ot
tn
1t
C - k) (1
C
Where C1, C2, C3 … Cn represents net cash inflows in years 1, 2, 3 … n;
K = opportunity cost of capital;
Io, ICo or Co = initial cost of the investment;
t = the time period of the cashflows; and
n = the expected life span of the investment.
It should be noted that the cost of capital „k‟ is assumed to be known and is constant.
In some literature it is represented as „r‟ and referred to as the discount or hurdle rate.
Higher cost of capital „k‟ is required for a very risky project, and in an economy with
very high inflation rate, as higher cost of capital reduces the NPV with which the
acceptance or otherwise of an investment is based (Welch, 2002).
According to Francis (1998), NPV can be interpreted loosely in the following
ways: when NPV > 0, then the project is profitable (worthwhile); when NPV = 0, the
project breaks even; and when NPV < 0, the project is not profitable (not worthwhile).
However, it is important to understand fully the phrase „project breaks even‟.
Consider the following example: Suppose we have N1,000 to invest in an investment
which returns a single inflow of N1,100 in a year‟s time, where the discount rate is
10%. If we put discount rate = investment rate = 10%, this will yield an NPV of zero.
Thus, breaking even here means, that the return from the investment is no better than
a safe investment of the original capital at 10% rate. Another way of interpreting this
is that the project earns exactly 10%, the opportunity cost of capital. In other words,
if the NPV of project is negative, this means that the project does not earn as much as
59
the discount rate (used in the calculation). Conversely, if the NPV is positive, we
assume that the project earns more than the discount rate.
Generally, NPV is an indicator of how much value an investment or project
adds to the value of the company. With a particular investment, if „Ct‟ is a positive
value, the investment is said to be in the status of discounted cash inflow in the time
of „t‟. If „Ct‟ is a negative value, the project is said to be in the status of discounted
cash outflow in the time„t‟. In essence, appropriately risked investments with positive
NPV could be accepted. This does not mean that such investment should be
undertaken in all cases, since the cost of capital „k‟, with which PV computation is
based may not have accounted accurately for the opportunity cost of capital (i.e. in
comparison with other investments). Similarly, where capital is limited and mutually
exclusive projects are involved, investments with positive NPV may still not be
undertaken. According to Allen (2006), in choosing among alternatives when
projects are mutually exclusive, the decision rule is to rank the projects according to
their relative net present worth. The project with higher NPV is presumed to be
preferable. Conversely, that NPV equals zero does not mean that an investment is
only expected to break-even, in the sense of undiscounted profit or loss (earnings).
Hence, it may show net total positive cash flow and earnings over its life.
The Net Present Value method of evaluating investments, so far, has been
assumed the best single technique for measuring the true value of investment
profitability; although its desirability heightens when used in conjunction with others
(Van-Horne, 1985; Eidleman; 1993: Matt, 2002; Pandy, 2006; Allen, 2006). This is
so because it exhibits all the desired decision rule properties. Even with such
attribute, it may be flawed in the calculation and selection of an appropriate discount
60
rate. The rate used to discount future cash flows to their present values is a key
variable in the process and use of NPV for investment appraisal. In essence a firm‟s
weighted average cost of capital (after tax) is often used, but many literatures believe
that it is appropriate to use higher discount rates to adjust for risk for risker
investments. A variable discount rate with higher rates applied to cashflows occurring
further along the time span of the investment might be used to reflect the yield curve
premium for long-term debt.
Another acceptable approach to choosing the discount rate factor is to decide
the rate which the capital needed for the investment could return if invested in
alternative venture (Okafor, 1983; Nwude, 2001; Hilton, 2004). Example, if the
capital required for investment „A‟ can earn 12% if alternatively invested, a 12%
discount rate is used in the NPV calculation to allow for a direct comparison between
the investment and the alternative or alternatives. Related to this concept is the use of
the company‟s „Re-investment Rate‟. Re-investment rate according to Brockington
(1998), is the rate of return for the company‟s investment on average. When
analyzing projects in a capital constrained environment (company) Brockington
further stated, it may be appropriate to use the re-investment rate rather than the firms
weighted average cost of capital as the discount rate; as it reflects the opportunity cost
of capital rather than the possibly lower cost of capital.
ii. The Internal Rate of Return (IRR) Method
The internal rate of return (IRR) method is another discounted cashflow
technique, which takes into account, the magnitude and timing of cashflows (Drury,
1992). Other terms used to describe IRR according to Drury are, yield on an
investment; marginal efficiency of capital; rate of return over cost, and time-adjusted
61
rate of internal return. The concept IRR according to Nweze (2004:182) is defined as,
„the rate at which the NPV is zero, the rate at which the PV of the cash inflows is
equal to those of the outflows, the hurdle rate, or the break even rate. Lucy
(1993:306) defines it as „the discount rate, which gives zero NPV‟. It is that discount
rate at which PV of the cash inflows for the investment will equal the PV of its cash
outflows. IRR is the highest rate of interest a firm would be ready to pay on the fund
borrowed to finance a project without being financially worse-off by repaying the
loan (principal and interest) out of cash flows generated from the project.
According to Okafor (1983:224) Van-Horne (1985:130), Lucy (1993:306), and
Drury (1992:146); the IRR is derived mathematically by solving the following
equation for „r‟:
r = 0C - k) (1
Cot
tn
1t
It should be of note that IRR computation becomes simpler when one
investment period is being discussed. When such is the case, the formula changes to r
= C1 – Co/Co. Hence r = C1/Co – 1; or C1/Co = 1 + r; or Co = C1/1 + r. From the
equation, Co = C1/1 + r, one would notice that the rate of return „r‟ depends on the
investment‟s cashflows rather than on any outside factor or factors; hence why it is
referred to as „internal rate of return‟ (Lucy, 2003). The IRR Lucy further stated is
the rate that equates the investment outlay with the present value of cash inflow
received after one period, hence there is no satisfactory way of defining the true rate
of return on capital assets.
It is in line with the above assertion of Lucy, that Francis (1998:308) adduced,
„there is no precise formula for calculating the IRR of a given project. However, it
62
can be estimated (using a linear interpolation technique), either graphically or by
formula‟. He further stated that both techniques need the NPV calculation using
different discount rates. Francis contends that, in order to estimate the IRR of an
investment graphically, that the following rules apply:
1. Scale the vertical axis to include both NPVs;
2. Scale the horizontal axis to include both discount rates;
3. Plot the two points on the graph and join them with a straight line;
4. Identify the estimate of the IRR where this line crosses the horizontal
(discount rate) axis.
This technique Francis demonstrated as follows, using investment result of a discount
rate of 15% yielding an NPV of N14,000; and discount rate of 17% yielding an NPV
of (N7,000).
Figure 2: Estimating an IRR graphically
20,000
10,000
0
-10,000
14 15 16 17 18
Discount Rate
Estimate of IRR = 16.33
N P
V
63
From the above figure 1, the estimated value of the IRR for this project is
16.33%. The graphical technique can be used with any two discount rates and their
respective NPVs. However, when estimating IRR graphically, when both NPVs are
positive or both negative, the value of the IRR obtained will lie outside the range of
the two given NPVs. Thus, to ensure that the horizontal discount rate scale is
adequate to „capture‟ the estimate, an expanse horizontal discount rate scale is applied
(Francis, 1998). Francis gave the exact formula equivalent of the graphical linear
interpolation thus, IRR = 21
1221
N - N
IN - IN
The computation of IRR in financial management is usually discussed under
two major methods, each depending on the flow of cash. They include:
i. The calculation of IRR for an uneven cash flow which involves in the main, the
determination of ‘r’ through the trial and error approach. Here, the method is
to select any discount rate in computing the present values of the cash inflows.
If the calculated PVs of the expected cash inflow is lower than the PV of cash
outflows, a lower rate will be tried. On the other hand, a higher value would
be tried if the PV of inflows is higher than the PV of outflows. This process
will be repeated until the NPV equals zero (NPV = O), at that point the IRR is
fixed. Hence, IRR is the rate at which a project will have a zero NPV.
ii. The calculation of IRR for an equal cashflows (that is, where an investment
generates Annuity), which is easier and straightforward. Here, IRR is
obtained simply by dividing the initial cost of the investment by the constant
annual cashflow.
Although IRR is inferior to NPV, it is similar to it and a popular investment
evaluation technique; since it measures the profitability as a percentage cashflow and
can be easily compared with the opportunity cost of capital (Nwude, 2001; Lucy,
2003). However, Lucy elaborated some problems that IRR method may suffer to
include:
64
1. Multiple Rate – A project may have multiple rates, or may not have a unique
rate of return, arising from the non uniqueness of the mathematical approach
to obtaining IRR.
2. Mutually exclusive projects – IRR may fail to indicate a correct choice
between mutually exclusive projects under certain situations. Example, when
IRR is used to evaluate non-conventional investment, it may yield multiple
IRR which will make decision making difficult.
The reason for more than one IRR lies on the algebra of IRR equation. The
formula for IRR is,
NPV = O C - r) (1
C ...
r) (1
C
r) (1
C
r) (1
Cn
n
3
3
2
21
o
i.e. NPV = O C r) (1
Cot
1
In solving for „r‟, the analyst is actually solving for „n‟ roots of „r‟. In case of
conventional investment, only one positive value for „r‟ exists, other roots
being either imaginary or negative. But in non-conventional projects, because
they involve more than one reversal of sign in cash flows, there is the
possibility of multiple positive roots of „r‟, often making choice very difficult
moreso in mutually exclusive projects.
3. Value Additive – Unlike the case of the NPV method, the value additive
principle does not hold when IRR method is used; IRRs of projects do not add
(Lucy, 2003). Thus, for projects A and B, IRR (A) + IRR (B) need not be
equal to IRR (A + B).
65
iii. The Profitability Index (PI) Method
Another time adjusted method of evaluating the investment proposal of a
company is the Profitability Index (PI), otherwise referred to as the Benefit Cost Ratio
(B/CR), or the Excess Present Value Index (EPVI). Profitability Index according to
Dam (2005) is the ratio of the present value of cash inflows, at the required rate of
return, to the initial cash outflow of the investment. It is the ratio of the sum of
present values of all the cash inflows and that of its initial cash outflow.
Chardwick and Kirkby (1995) stated that the Excess Present Value Index is
merely a variant of the basic NPV method and is the ratio of the NPV of a project to
the initial investment. In essence, profitability index is a measure of relative and not
absolute profitability; hence suffers from the same general criticisms as the IRR when
used for ranking purposes.
The PI compares the estimated cash inflows of a given investment with the
cost of such investment (the investment initial outlay). The NPV of such
investment‟s estimated inflow as compared to the initial outlay determines the
viability of such investment. Where the cost of investment (initial outlay) is more
than the calculated NPV (i.e. where PI < 1), investment is rejected. If not, the
investment will be accepted (Nweze, 2004).
Mathematically, the PI of a project can be arrived at using the formula.
PI = ot
t
o
t C k) (1
C
C
)(C PV
outlaycash Initial
inflowscash of PV
The PI makes it possible to rank investments according to their ratios. This is
usually the case when multi-investments that are independent are being considered.
Since there may not be enough fund (capital) to finance all the investments with
66
positive NPV, it becomes imperative to ration. As such, PI will be used to rank these
investments according to their benefit ratios (Allen, 2006).
B. The Non Discounted Cash Flow
The Non Discounted Cash Flow criteria are otherwise referred to as the
traditional method of investment appraisal. Though they are the original methods
used in investment appraisal, the usefulness has been short charged due to their
inability to reflect the time value of money. It is an important criterion in evaluating
or comparing investments or purchases of capital assets; other things being equal, but
the usefulness of this approach is limited because it does not emphasize the time value
of money (Eidleman, 1993). The following are the methods generally adopted under
the non-discounted cash flow investment evaluation method: i. the payback period
method; ii. the accounting rate of return method; and iii. the discounted payback
period.
i. The Payback Period Method (PBP)
The payback period (PBP) is one of the traditional methods of capital
budgeting. Wild, Larson and Chiappetta (2005) defined PBP as the expected time
period to recover the initial invested amount. They further stated that managers prefer
investing in assets with shorter payback periods to reduce the risk of an unprofitable
investment, over investing in the long run. Acquiring assets with short payback period
reduces a company‟s risk from potentially inaccurate long-term predictions of future
cash flows.
Williams (2008) defined PBP as, the period it took an investment project to
recover initial cash investment. That is, the ratio of the initial fixed investment over
the annual cash flows through the recovery period. In essence, PBP = Initial fixed
67
investment ÷ Annual cash inflows. Similarly, Govindarajan and Anthony (2004)
opined, PBP is the length of time within which all benefits received from an
investment can repay all costs incurred. They argued that PBP is the simplest
technique for appraising capital expenditure decisions. This is because of its ability to
answer the question, how many years will it take for cash benefits to pay the original
cost of an investment, normally disregarding salvage value? The simplicity of the
response to this question makes PB the simplest most widely used capital investment
technique, hence Cash benefits as used represents Cash Flow After Tax (CFAT).
However, Hampton (1986), though in acceptance that PBP method is the
simplest and most widely used, cautioned that it should only serve as a supplementary
tool in the evaluation of capital investment, as it is not an appropriate method of
measuring profitability of an investment project. In the same vein Drury (1992)
stated that, for simple investment situations, PBP is a measure of how fast the initial
outlay is repaid, but not a measure of project potential. Thus, he defined PBP as, the
number of years required to recover the original cash outlay invested in a project.
The PBP like every other investment evaluation technique has a method of
ranking projects. They compare the projects pay back with a predetermined standard
payback. The project would be accepted if its payback period is less than the
maximum or standard payback period set by management. As an evaluation
technique, it ranks as best the project which has the shortest payback period. Thus, if
the company has to choose between two mutually exclusive projects, the project with
shorter payback period will be selected.
The PBP is a popular investment criterion used in practice by business
executives that consider the simplicity of the method as a virtue (Lucy, 2003). Other
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reasons why the PBP is regarded and relied upon heavily for investment appraisal in
practice, according to Wild, Larson and Chiappetta (2005) include: its cost
effectiveness, as it costs less than most of the other sophisticated techniques; its
ability to shield risk, as the risk of the project can be tackled by having a shorter
standard payback period which ensures guarantee against loss; and its ability to give
insight into the liquidity of the project. The ability to give insight into the liquidity of
the project will enhance efficient resource use in terms of funds so released.
However, with all these enlisted benefits of PBP, Pandy (2006:140) viewed
that “the payback may not be a desirable investment criterion since it suffers from a
number of serious limitations”. Such limitations he elaborated to include:
1. Ignoring Cash Flows After Payback – pay back fails to take account of the
cash inflows earned after the payback period. It is not an appropriate method
of measuring the profitability of an investment project as it does not consider
all cash inflows yielded by the project;
2. Cash Flow Pattern – PBP fails to consider the pattern of cash inflows. That is,
the magnitude and timing of cash inflows. In other words, it gives equal
weight to returns of equal amounts even though they occur at different time
periods.
3. Administrative Difficulties – A firm may face difficulties in determining the
maximum acceptable payback period. There is no rational basis for setting a
maximum payback period. It is generally a subjective decision.
4. Inconsistent with Shareholders Wealth Value – payback is not consistent with
the objective of maximizing the market value of the firm‟s shares. Share
values do not depend on payback periods of investment projects.
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ii. The Accounting Rate of Return Method (ARR)
The Accounting Rate of Return (ARR), also known as Average Rate of Return
or Return on Investment (ROI) is another traditional or non discounted technique used
for the evaluation of investment proposals. Nolon (2005) defined ARR as the ratio of
average annual profits after depreciation, to capital invested. Porwal (1976) viewed it
as the ratio of the average investment. ARR is an investment analytical technique,
which uses accounting information as revealed by the financial statements to measure
the profitability of an investment. It can be found by dividing the total of the
investment‟s book values after depreciation by the life span of the project. ARR is an
average rate of an investment cashflow, and can be determined by the equation: ARR
= .Investment Average
Income Average
The average Income Porwal defined as earnings after taxes without an adjustment for
interest {EBIT (1-T)}/n or Net Operating Profit After Tax.
Therefore, ARR = )/2
n1
o(1
/nn
1t
T)(1t
EBIT
Where, EBITt = earnings before interest and taxes in the period t;
T = the tax rate;
Io = the book value of investment in the beginning;
In = the book value of investment at the end of „n‟; while
n = the number of years.
The accept or reject criterion being applied under ARR method is, accept all
those projects whose ARR is higher than the minimum rate established by the
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management, and reject those projects which have ARR less than the minimum rate.
This method will rank a project as number one, if it has the highest ARR, and in that
other, the lowest as that with the lowest ARR.
Pike (1992) advocated that an evaluation of the ARR method shows the merits
of, simple and easy to understand; its base on accounting concept of profit, making
for easy calculation; the totality of benefits associated with the project as is used in
ARR computation given due weightage for the profitability of the project; and
because profits as is used, is that which is obtained after deducting depreciation and
taxes, it serves a better base for decision making. However, the deficiencies of the
ARR method according to Pike include;
1. The use of accounting profits instead of cash flows in appraising projects.
Accounting profits are based on arbitrary assumptions and choices, and also
include non-cash items. It is therefore inappropriate to rely on them for
measuring the acceptability of projects;
2. It does not take into account the time value of money. The timing of cash
inflows and cash outflows is a major decision variable in financial
management decision making. Accordingly, benefits in the earlier years and
later years cannot be valued at par. To that extent, the ARR method treats
these benefits at par and fails to take into account the difference in the time
value of money.
Williams (2008) also suggested the use of arbitrary cut off yardstick as another
deficiency of the ARR method. Williams posit that, the company employing the
ARR rule uses arbitrary cutoff yardstick as the company‟s current returns on it‟s
assets book value. Because of this, the well to do companies earning very high rates
on their existing assets may reject profitability projects (i.e. projects with positive
NPVs) and the less profitable companies may accept bad projects (i.e. projects with
negative NPVs). The ARR method though is continually in use as a performance
71
evaluation and control measure in practice, its use as an investment evaluation
criterion is currently undesirable; as it may lead to unprofitable allocation of capital.
iii. The Discounted Payback Period (DPBP) Method
A recent development in the traditional method of investment evaluation
technique is the Discounted Payback Period (DPBP). This method was introduced to
counter the major deficiency of the PBP, which does not discount the cash flows
before calculating the payback. Though this method fails to consider the cash flows
occurring after the payback period, it takes into account the number of periods taken
in recovering the investment outlay on the present value basis. The DPBP criterion
for investment evaluation will always show a longer payback period than the ordinary
PBP because its calculation is based on the DCF. The discounted PB rule is seen a
better and more realistic method of evaluation as it discount the cash flows until the
outlay is recovered. But even at that, it still does not take into consideration the entire
series of the cash flows just like other traditional methods of project evaluation
(Pandy, 2006).
Conclusively, it may be pertinent to emphasize that the major decision of the
management which determines the company‟s future prospect or otherwise is hinged
basically on capital budgeting decision. Whenever the management is faced with
capital investment decision, the one and most appropriate tool to resort to is the
capital budgeting techniques. It is advised that no one of the methods discussed is
error free hence a choice made through the use of some methods will ever be better.
Bierman and Smidt (1990) suggested the following general guidelines as have stood
the test of time, „and a must to be adhered to, when management is faced with the
problem of selection of the choicest investment, using capital budgeting techniques:
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1. Focus on Cash Flows, Not Profits: One who wants to get as close as possible
to the economic reality of an investment focuses cash flows not profits.
Accounting profits contain many kinds of economic fiction. Flows of cash on
the other hand are economic facts.
2. Focus on Incremental Cash Flows: The reason for the whole analytical
exercise is to judge whether the firm will be „better off‟ or „worse off‟ if it
undertakes the investment. Thus, one wants to focus on the changes in cash
flows affected by the investment. The analysis may require some careful
thought; an investment decision identified as simple „go or no-go‟ question
may hide a subtle substitution or choice among alternatives. For instance, a
proposal to invest in an automated machine should trigger off many questions:
will the machine expand capacity? and thus, permit us to operate more
efficiently than before we had the machine?; will the machine create other
benefits (example, higher quality, more operational flexibility etc.)? The key
economic question asked of investment proposals should be, “how will things
change (i.e. be better or worse) if we undertake the project”.
3. Account for Time: Time is money. Investors prefer to receive cash sooner
rather than later, hence NPV is used as a technique to summarize the
quantitative attractiveness of an investment. NPV can be interpreted as the
amount by which the market value of the company‟s equity will change as a
result of undertaking the investment.
4. Account for Risk: Not all investments present the same level of risk. Investors
want to be compensated with a higher return for taking higher risks. The way
to control for variations in risks from investment to investment is to use a
discount rate to value a flow of cash that is consistent with the risk of that
flow.
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Utilization of Capital Budgeting by Manufacturing Companies for Investment
Analysis
Capital budgeting is the process of analyzing alternative long-term
investments and deciding which assets to acquire or sell. These decisions can involve,
developing a new product or process; buying a machine/equipment or a building; or
even acquiring an entire company. All focusing one objective, satisfactory return on
investment for shareholders wealth maximization. Capital budgeting has proved one
and the major approach a company could use, in order to invest its current funds most
efficiently in the long term assets; in anticipation of expected flow of benefits that
would maximize the shareholders wealth. In other words, manufacturing companies
that want to remain in business and competitive too, must adopt the use of capital
budgeting in analyzing its investment decisions of expansion, acquisition,
modernization and replacement of long-term assets (Wild, Larson and Chiappetta,
2005).
Capital budgeting decision making is invariably a top management exercise.
While the financial managers (Accountants) plan, develop and compute the capital
budgeting appraisal techniques, capital budgeting decision is solely a top management
exercise. This gap Imegi and Anamakiri (2004) affirm is the starting point of conflict
in the use of capital budgeting by manufacturing companies for investment decision.
Similarly Nwude (2001) argued that the organization of the finance functions of a
typical Nigerian manufacturing firm is another point of conflict as often the finance
manager‟s position in capital budgeting decision is usually slim. The finance
functions of a typical Nigerian manufacturing firm he elaborated in the below
organigram.
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Figure 3: Organization of Finance Functions in a Typical Nigerian Manufacturing
Firm.
Adapted from: Basic Principles of Financial Management – A First course. By
Chuke Nwude, 2001:13
From the above organization of finance functions in figure 3, one can assert
that the „line‟ financial managers build/compute the capital budgeting appraisal
techniques under the supervision (chairmanship) of the AGM Finance Services – the
Deputy Director or Chief Accountant (as designation of financial officers differ from
company to company). The major financial decisions (capital budgeting decision
inclusive) are taken by the Board of Directors. The Chief Financial Manager (DGM
finance) who in most cases is „just‟ a member of the Board may atimes take this
decision but often with due allegiance to the Board of Directors. This is irrespective
Board of Directors
Managing Director (CEO)
DGM (sales or Director DGM (Finance) or Director DGM (Human Resource)/ Director
AGM (Treasury Services) or
Deputy Director
AGM (Financial Services) or Deputy
Director or Chief Accountant
Mgr.
Credit
Mgr.
Inventory
Mgr.
Cost
Acct
Mgr.
Benefits
Mgr.
Planning &
Budgeting
Mgr.
Audit
Mgr.
Evaluation
Mgr.
Financing
Accounting
& Tax
Matters
75
of the official functions of the Chief Financial Manager, which according to Nwude
include:
1. Raising of funds to meet the needs of the firm;
2. Participation in allocating the funds productively;
3. Interaction with other executives in the firm to fix product price, costs of
operations, volume of output and product lines in order to make profit as well
as plan for unexpected events‟;
4. Full understanding of the environment and markets within which the business
operates, especially how to measure the risk and floatation of financial
instruments;
5. Planning of the company‟s capital structure and its modifications. In
performing this role, cost, risk, control and flexibility are some of the factors
that must be taken into account;
6. Planning and management of long term investments;
7. Management of working capital; and
8. Determination of the appropriate dividend policy.
These official roles were suggestive that the financial manager should
spearhead major finance decisions of the organization, and which capital budgeting
decision is at the apex. Yet, inspite of all these roles (official functions), the DGM
finance is not just a member of the top management who takes capital budgeting
decisions; he is but „alone voice‟ as his suggestion or suggestions, may not matter
much in accepting or rejecting a capital investment decision (Klammer, 1992; Osaze,
1996; Hartman and Vassen, 2003).
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The utilization of capital budgeting by manufacturing companies in analyzing
investments according to Bruner (2002) have always had some impediments. The
complexity in the management of the organization, the non availability of the required
number of computers, and the size and risk complexities of the project are but a few
conflict situations that distort project appraisal results. Bruner further stated that
some projects are so complex that its riskyness could hardly be determined with the
use of investment appraisal techniques. He concluded that even in the computer era
of today, that most manufacturing company in the developing nations has not
provided computers for their financial manager‟s easy assessment of projects and
investment evaluation. And in some companies where these required information
technology are provided and applied, the decision makers (top management) may not
be knowledgeable in their application and use.
According to Nnoli (2004), the financial difficulty that had forced so many a
company to wind-up is basically rooted in ignorance of, and lack of proper
interpretation and analysis of the investment appraisal techniques by the top
management (who often claim to know) and in whom the decision on where, when
and how much to invest are relied upon. Nnoli viewed that investment appraisal
techniques as prepared by the financial expert may be very efficient in project ranking
and selection of profitable investment, but due to fear, often caused by lack of
understanding of the appraisal techniques by the top management, decisions are often
taken arbitrarily; and by intuitive understanding of the situation.
Similarly, Wild, Larson and Chiappatta (2005) argued that in some cases, that
manufacturing companies consider as convenient and prestigious the use of
environmental considerations rather than strictly quantitative investment analytical
77
factors. They concluded that, „in all situations, managers can reach a better
investment decision if they identify the consequences of alternative choices in
financial terms and with investment evaluation techniques‟.
In their own view, Klammer (1992), Hendricks (1983) and Bodernhorn (2002)
emphasized that project ranking points to another controversy in investment project
selection, even when the top management (decision makers) decides to adhere to the
investment appraisal techniques. This is because, to be more accurate, no one method
is used, and no two or more methods as may be used, selects the same project
investment in all cases, and using different discount rates or cost of capital.
However, the Association of Certified and Chartered Accountants (1998)
advised that a formal document, the Capital Budgeting Policy Manual be established
in every company to ensure that all capital asset‟s proposals are reviewed fairly and
consistently. The manual they contended will help to ensure that managers and
supervisors who make proposals will do that in line with what the organization
expects the proposal to contain, and on what basis their proposed projects will be
judged. Also, the top management who have the authority to approve specific
projects will have to exercise that responsibility in the context of an overall
organizational capital expenditure policy. They specified that the outline of the
policy manual should contain the following:
1. An annual updated forecast of capital expenditure;
2. The appropriate steps to be taken (capital investment decision processes);
3. The appraisal method or methods to be used to evaluate proposals;
4. The minimum acceptable rate or rates of returns on project of various risks;
5. The limits of authority;
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6. The control of capital expenditure; and
7. The procedure to be followed when accepted projects would be subjected to an
actual performance review after implementation.
A strict adherence to this capital budgeting policy manual outline is believed
will cause manufacturing companies to utilize capital budgeting efficiently and
effectively in their investment analysis.
Outsourcing of Capital Expenditure Decisions and the Prospect of
Manufacturing Companies
Outsourcing according to Koszewska (2004) has been a very successful and
increasingly popular enterprise management strategy. Though it may be seen as an
emerging management strategy, it has made a mark in strengthening a given
company‟s position especially in the face of the growing competitive pressures and
progressing globalization. Koszewska, defined outsourcing as the utilization of
external resources, the commission of the execution of tasks, functions and processes
as cannot be efficiently handled in-house to an external provider specializing in a
given area.
According to Quelin and Duhamel (2002), it is the operation of shifting a
transaction previously governed internally to an external supplier through a long term
contract, and which may involve the transfer of staff to the vendor for the firm. In
essence outsourcing is the contracting out of a company‟s responsibility or
responsibilities to an expert external provider. The vendor company must have
competent and capable hand or hands to handle such task as is contracted to it. And
the process of outsourcing can only be embarked upon when such task to be
contracted out does not constitute the company‟s basic and strategic functions. In
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essence, the company contracts out those necessary but unrelated company‟s basic
functions to an expert external provider so that the company can concentrate on its
strategic tasks and goals (the core activity), hence reduce prime cost (Earl, 2001).
Aurbert, Patyr and Rivard (1998) affirm, outsourcing is the significant
contribution by external vendors in the physical and, or human resources associated
tasks, where the entire or specific components of the infrastructure in the user
organization is hired from an expert provider. It occurs when an organization
contracts a service provider to perform a function, which it cannot very well perform
by itself. Outsourcing is a decision taken by an organization to contract out or sell the
organization‟s assets, people, and/or activities to a third party specialist vendor, who
in return provides the services for a defined time period, and at a cost.
Outsourcing as a management strategy dates back to the 1970‟s in the United
States of America which was assumed the first frontiers of this practice. As at the
commencement of the practice, only large corporations used it. However, with the
millennium competitive pressures and progressive environmental challenges of
globalization, outsourcing became more popular amongs small-sized companies in the
late 1990‟s and till date (Koszewska, 2004). Koszewska cited the survey conducted
by Fortune Magazine, which discovered that over 90% of business organizations in
the US to date, take advantage of external service provider (outsourcing) to maintain
their market share, to buttress his point. This makes it imperative that outsourcing is
a beneficial management strategy. Other benefits of outsourcing which influences the
wealth base of manufacturing companies according to Koszewska (2004), Earl
(2001), and Aurbert, Patyr and Rivard (1998) include: reduced overhead and
operational costs; possibility of converting fixed costs into variable costs; price
80
competitiveness; lower involvement (freezing) of capital; improved cost control;
higher flexibility, the ability to meet fluctuations in demand; easier and more
economic access to the latest technologies; improved quality; possibility of
concentrating on the company‟s core business functions and improvement on
measurability of costs. Others include, better control of internal departments;
availability of new service options, and reduced capital commitment; access to
external competences; acquisition of specialist expertise; and the ability to spread
commercial risk.
With these elaborate benefits, one may contend that outsourcing should be the
strongest and most sustained trend in business management. Nevertheless, Gartner
(2004) reported that, as many as 80% of outsourcing contracts are unproductive, and
that European business wasted N7 billion on poorly managed outsourcing deals. This
assertion points to the fact that though the enormous benefits of outsourcing, that
some risk complexities are involved in outsourcing decisions. Outsourcing when
trivially handled, will doom the contracting company. In essence, to reap the benefits
of outsourcing, Gartner prescribed the following as guides: determining what task or
tasks should be accomplished in-house; determining which task or tasks should be
accomplished through strategic partnership; and determining which specific task or
tasks to be contracted out (outsource) to third-party specialists.
Similarly, Earl (2001) asserts, a company that must outsource has to know the
related risks and threats, and plan well on how it should be averted to be able to reap
the benefits of outsourcing. The outsourcing company has to trust the external service
provider, and know well her potentials before a task is contracted to it. In his own
view, Koszewska advocated that a firm using outsourcing inevitably looses some
81
control over its future, which to some degree is given over into the hands of another
firm, whose primary motive (one should bear in mind) is the maximization of its own
profit. Other major risks of outsourcing include, dependency on the supplier/vendor,
hidden costs; loss of know-how (i.e. loosing touch with new technological
breakthroughs that offer opportunities for product and process innovations), loss of
long-run research and development competitiveness, the risk of co-operating with a
dishonest supplier which having gained access to knowledge concerning the company
and its products, may use it against the company in the future; service provider‟s lack
of necessary capabilities; and communication and co-ordination difficulties.
According to Quelin and Duhamel (2002), the whole process of outsourcing
decision requires a great deal of effort and careful examination throughout the whole
process until the decision is finalized. They suggested the following „success
foundation steps‟ as should be adhered to, before finalizing the outsourcing decision:
a. set the strategic direction of the organization; b. identify the core competency and
set its tactical objectives; c. develop a list of the company‟s intended outsourcing
providers (supplier/vendors); and d. choose the outsourcing decision (for instance, to
outsource because of short term capacity, staffing, or production problem). Note that,
it is pertinent that the corporate leadership of the company must identify the
framework of the organizational strategic goal in order to set the overall direction for
making achievable outsourcing decisions. There is always the need to evaluate the
organization‟s core competency and capacities through the overall orientation of its
strategic goals. This will aid outsourcing decision making by simplifying the process.
Core competencies defines the business unique and exclusive abilities, strengths and
82
weakness; while core capabilities, serve as an indicator of the overall out look of the
company‟s business (Quelin and Duhamel, 2002).
Effects of Utilization of Capital Budgeting on Company’s Earnings
Every investment activity has a definite or implied costs and benefits. In
companies and other business organizations alike, the ultimate consequence of
investment activities are expressed in terms of cash flow; that is, the receipts (cash
inflow) or payments (cash outflow) of cash by the organization (Brealey and Myers,
1991). Within a typical business period, businesses make series of cash payments and
receive series of cash benefits. Where the cash inflow of a period exceeds the
outflow, we assume a net cash inflow (business earnings); or simply put, that a profit
has been realized. In essence, the company‟s earning is the profit, the net cash inflow
accruing to it as a result of its business activity/activities or investment (Bierman and
Smidt, 1990).
Investment decisions are conducted under three possible environmental
conditions, viz: conditions of certainty; conditions of risk; and conditions of
uncertainty (Okafor, 1983, Nwude, 2001 and Pandy, 1998). Okafor further stated that
these three conditions relate basically to the state of an investor‟s knowledge about
the underlying factors, which affect the outcome of his investment decision. The
implication is that, these three environmental conditions may be seen as relative and
dependent on the investor‟s knowledge of financial management; even when they are
regarded as decisive to the earning base of every company. Conditions of certainty
can be said to prevail where a potential investor has full knowledge of the ultimate
outcome of an investment. This implies, (i) perfect knowledge from the start, of the
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exact nature and timing of the stream of cash flow to be expected from an investment
opportunity; and (ii) the expectation or belief that the anticipated (ultimate) outcome
would not be subject to chance. A condition of uncertainty arises when an investor
have a rear complete ignorance of the future outcome of his present decision. That is,
the decision maker has no dependable information about the nature or significance of
factors, which affect his investment activities. When such is the case in practice, the
decision maker generates a probability distribution of possible outcomes on the basis
of his personal judgement of the situation. And by so doing, Okafor (1983:26) stated,
„a condition of uncertainty would, at least conceptually, be reduced to one risk‟.
The term risk has varied definitions and meanings. Literally, it means
exposure to danger or economic adversity. The Cambridge International Dictionary
of English sees risk as danger of loss or harm. Risk is used as a surrogate for the
likelihood of loss or the potential size of such loss (Okafor, 1983). In insurance, the
term risk refers to the object/person or property, being insured. Hilton (2004) defined
risk as, that which arises in investment situation because we cannot anticipate the
occurrence of the possible future events with certainty and consequently cannot make
correct prediction about cash flow sequence. However, risk will be used here to
denote exposure to loss arising from variations between the expected and the actual
outcome of investment activities. As such, if possible outcomes are wide, risk would
be high; while a narrow range of possible outcome means a low exposure to risk.
Consequently, conditions of risk imply, incomplete knowledge as well as incomplete
ignorance of the future outcome of investment activities (Merrett and Sykes, 1992).
According to Nwude (2001), every investment environment is surrounded by
two types of risks, namely: the „alpha‟ () and the „beta‟ () risks. He classified alpha
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risk as the unsystematic; diversifiable, specific or non market imposed risks peculiar
to an investment activity. Such risks are that caused by poor management, loss of key
personnel, location of businesses, dependency on limited market, nature of product
and so forth; hence are seen as avoidable risks. While beta risks, also known as
systematic, undiversifiable, non specific or market imposed risks, are the unavoidable
risks caused by such factors as, inflation; political conditions or factors; policy
inconsistencies; war; natural calamities and other economic downturns. The
underlying principle with which every investment analysis is based is to avert or
minimize this unavoidable market imposed risks which is the major determinant of
business earnings.
The use of capital budgeting techniques for investment analysis has proved
one, and a major reliable way in which business risks can be minimized or obviated
(Merrett and Sykes, 1992; Nwude, 2001; and Hilton, 2004). In the words of Nwude
(2001:267), “effective capital budgeting will improve the timing of assets‟ acquisition
and quality of each assets purchased, hence boost the earning capacity of the firm”.
Similarly, Merrett and Sykes (1992) viewed that capital budgeting or investment
decision are of considerable importance to the company since they tend to determine
its value (earnings) by influencing its growth, profitability and risk. The following
according to Hilton (2004) are other ways in which capital budgeting could boost the
earnings of companies:
1. Forced Planning: Capital budgeting compels management to carefully analyze
any investment in asset or assets before embarking upon them. This instills in
the managers the habit of being conscious of the result of improper capital
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budgeting. As such, they carefully use the appropriate evaluation technique or
techniques before any selection is made of capital asset.
2. Co-ordinated Operations: Appropriate capital budgeting helps investors to co-
ordinate, integrate and balance the efforts of various departments in the light
of the overall objectives of the company. The result of the goal congruency
and harmony among departments, units, or cost centers, is effective and timely
selection of capital assets for profit enhancement.
3. Performance Evaluation and Control: Capital budgeting facilitates control by
providing definite expectations in the planning phase that can be used as a
frame of reference for judging the subsequent performance or achievement of
the capital asset in question. Undoubtedly, budgeted performance is a more
relevant standard for comparison, than past performance which is usually
based on historical factors that are constantly changing.
4. Effective Communication: Budgeting generally improves the quality of
communication. The company objectives, budget goals, plans, authority and
responsibility and procedures to implement plans are clearly written and
communicated through budgets to all individuals, cost centres and units in the
enterprise. This results in better understanding and harmonious relationship
among managers and subordinates, thus fosters company‟s goal attainment.
5. Optimum Utilization of Resources: Capital budgeting ensures that the
company‟s resources are used to capacity. More often, the volume of sales
determines the size and nature of machines and equipment to be procured. The
procurement of the required capital assets at the appropriate time frame results
in full capacity utilization, which in turn boosts profitability. Companies that
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optimize the use of its resources direct its total effort towards the most
profitable channels.
6. Enhancement of Productivity: Efficient and effective capital budgeting
improves and maintains optimum productivity. The company produces to
capacity hence maintains, and with time, expands its market share. Increase in
a company‟s market share will lead to increase in productivity through
boosting of the employees‟ moral via increased emolument. Generally, the
result of the employees full participation in the formulation of the company‟s
plans and policies are seen manifest in their harmonious pursuit and
achievement of the company‟s goal.
7. Profit Mindedness: Capital budgeting develops an atmosphere of profit
mindedness and cost consciousness, thereby facilitating improved earnings.
8. Management by Exception: It permits management to focus its attention on the
significant matters through budgetary reports. This saves management the time
and energy that could have been wasted in irrelevant issues and processes.
In summary, effective capital budgeting measures efficiency, permits
management‟s self-evaluation, and indicates the progress so far attained, so that
adequate corrective measures could be taken.
However, the reaping of the varied benefits of capital budgeting may turn a
mirage if management becomes carefree in the handling of the unavoidable market
imposed risks (Walter, 1992). The management in order to reap the numerous
benefits of capital budgeting, must not depend solely on investment evaluation
techniques without evaluating for the risks which capital expenditure decisions are
tied to, Walter further stated. All investment projects involve some level of risks,
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hence future cashflow cannot be predicted with absolute certainty. Risks arise
because we cannot anticipate the occurrence of the possible future events with
certainty, and consequently cannot make correct predictions about cashflow sequence.
In essence, a capital budgeting decision may not be sound to boost the earnings of a
company if taken on the basis of only one set of assumption, profitability. Risks
should be associated with profitability assumption as it portends variability of future
returns estimated of any project. The greater the variability of expected returns, the
riskier the project, thus, the riskyness of an investment needs to be evaluated before
such investment is embarked upon, at least to minimize the risk of failure
(Bodernhorn, 2002).
Risks can be evaluated for more precision in reaching investment decisions by
the application of statistical techniques. These statistical techniques drawing from the
fields of mathematics, logic, economics and psychology, enable the decision maker to
take decisions under risk and uncertainty with approximate precision (Pandy, 1999).
These statistical techniques according to Pandy, include: probability, ENPV, standard
deviation and variance and coefficient of variation.
1. Probability
Risks exist because of inability of the decision maker to make perfect forecast.
Forecasts cannot be made with precision, perfectness or certainty because the future
events, on which they depend on, are uncertain. A typical forecast is a single figure
for a period, which is referred to as the „best estimate‟, or „most likely‟ forecast.
Basing estimate on one figure or value limits every decision analysis in two ways.
First, the chances of this figure actually occurring is not known due to the uncertainty
surrounding it. Secondly, the meaning of „best estimate‟ or „most likely‟ is never
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clear, as it is not known whether it is the mean, median or mode. For this reason, a
financial analyst should not give just one estimate, but a range of associated estimates
(a probability of distribution), Pandy further stated.
Francis (1998) defined probability as the possibility of occurrence of a sample
point in the long service of an experiment or event. He distinguished between two
classes of probability, namely: the theoretical probability; and the empirical
probability. When a probability is calculated without the experiment being performed
(that is, using only information that was known about physical situation), such
probability is referred to as theoretical probability. While a probability that is
calculated using results of an experiment as performed a number of times is referred
to as, empirical or subjective probability. In each of the above classes, the probability
as a statistical technique for analyzing risk measures opinion about the likelihood that
an event or situation will occur out of other possible outcomes of the same event or
situation.
Mathematically, probability is expressed as, P (E) = f
f(E)
Where: P(E) = the probability of event (E)
f(E) = the number of times that event (E) has occurred
∑f = the total frequency (i.e. the total number of times of
performing the experiment).
If an event is certain to occur, the probability of such event is said to equal one
[P(E) = 1]. If it is certain that the event will not occur, the probability equals zero
[P(E) = O]. Thus, the probability of all events to occur lies between zero and one.
Although the probability distribution may consist of a number of estimates, financial
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analysts uses the simple form, which consist of only a few estimates (Graham and
Harvey, 2001). Similarly, Lucy (2003) opined that the major probability distribution
used by financial analysts is that which only employs high, low, and best guess; or
optimistic, most likely, and pessimistic estimates. For example, as against one value
forecast, one may assume that the annual cashflow expected from an investment
could be N10,000, N9,000 or N3,000:
Assumptions Cashflow (N)
Best Guess 10,000
High Guess 9,000
Low Guess 3,000
Though it could be easily seen that this is an improvement over the single
figure forecast, more information can still be discovered by graduating these estimates
according to the analyst‟s degree of confidence. According to Pandy (1998), the
analyst will be more precise in her estimate when his feelings are graduated according
to his degree of confidence on the probability of these estimates occurring, thus:
Assumption Cashflow (N) Probability
Best Guess 10,000 0.2
Best Guess 9,000 0.6
Low Guess 3,000 0.2
By assigning this probability values, the analyst provides useful information,
which is very useful in assessing more clearly the impact of each variable. At least,
one can see that the chances of high guess (one of the variables) occurring is more, its
chance of accruing being 60%. The other two variables having a 20% chance of
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occurring, each. In essence, the most likely estimate as should be used by the analyst
can now be selected with more precision.
2. Expected Net Present Value (ENPV)
The use of statistical techniques to analyze the risk features of an investment
follows a sequence. Once the probability assignment has been completed of the future
cashflows, the Expected Net Present Value of the cashflows is sought. The ENPV is
found by multiplying the monetary values of the possible events (cashflows) with the
probabilities. That is, the ENPV equals, the sum of the present values of the expected
net cashflows divided by their discount rates.
According to Wayne (1992), the use of ENPV as investment evaluation
criteria is one of the ways in which unpredictable economic conditions and risks
could be incorporated into capital budgeting analysis. The possible events
(unpredictable economic conditions and market imposed risks) are graduated into
high growth risk, average growth risk, and low or no growth risk and probability
values assigned it. It is with this probability values that the ENPV is computed. In all,
investment project with a higher ENPV is always preferred to that with a lower value.
3. Standard Deviation and Variance
Although through the calculation of ENCF and ENPV, risks are explicitly
incorporated into capital budgeting analysis, Merrett and Sykes (1992) opined, a
better analysis is said could be obtained by finding the dispersion (variability) of
cashflows (NCF) from the ENCF. According to them, the fluctuations or variability
in returns as caused by risks (example, volatility in prices) can be better measured
through the two measures of dispersion, namely; the variance and the standard
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deviation. The variability of rates of return they defined as, the extent of deviations
or dispersions of the individual rates of returns from the average rate of return.
Van-Horne (1986) defined standard deviation as a measure of risk that gives
the information about the dispersion or tightness of the probability distribution of
possible cashflows. Standard deviation measures the deviation or variance on
expected cash flows of each of the possible cash flow. That is, while the variance
measure how the individual NCF has deviated from the ENCF or the dispersion of
cashflows, the standard deviation is the square root of the variance. This dispersion
of cashflow indicates the degree of risks. In line with the above assertion, Pandy
(2006) opine, variance or standard deviation is seen as absolute measures of risk.
4. Coefficient of Variation (COV) as a Relative Measure of Risk
Coefficient of variation is a statistical method of measuring the relative
dispersion of risk. Hampton (1986) defined COV as a comparative evaluation of the
magnitude of risk inherent in a proposal or an investment. It measures the standard
deviation of the probability distribution as a factor of its expected value. In the words
of Hampton, the Coefficient of Variation is a useful measure of risk when we are
comparing projects, which have: i. the same standard deviation but different expected
values; or. ii. Different standard deviation but the same expected values; or iii.
Different standard deviations and different expected values.
Conventional Techniques of Risk Analysis
Apart from these sophisticated statistical techniques for analyzing and
handling risks there are other popular conventional techniques used by managers to
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handle risks that obviate the use of capital budgeting in investment analysis. They
include:
1. Pay Back
Pay Back (PB) has previously been discussed as a measure of profitability. In
practice, it is more of an attempt to allow for risk in capital budgeting decision rather
than a method of measuring profitability (Brigham, 1979). Brigham further stated that
pay back make allowance for risk by, i. focusing attention on the near term future of
capital recovery, thereby averting risks by concentrating on the liquidity of the
company; and ii. Favouring short term projects over what may be riskier, long term
projects. It may be reiterated here that PB as a method of risk analysis is useful only
in allowing for a special type of risk. That is, the risk that an investment will run
exactly as planned, and will suddenly cease altogether to worth nothing. It is
essentially situated to the assessment of risks of time nature (i.e., such risks as, civil
war in a country; closure of business due to inordinate strikes by workers,
introduction of new product by competitors which captures the whole market, and
natural disasters such as flood or fire).
The problems with PB as a method of risk analysis are, i. the usual risk
anticipated of a business is not that an investment will run for a period of time and
then collapse as is forecasted, rather, that the forecast of cashflow will go wrong due
to lower sales, high cost of production and so forth; and ii. Even as a method of
allowing risk of time nature, it ignores the time value of cash flows (Hampton, 1986;
Brigham, 1979). It does not portray the fact that projects with earlier capital recovery
are preferred to that with a later capital recovery, when they have the same PB period.
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2. Risk Adjusted Discount Rate (RADR)
Another conventional technique for analyzing risks of capital asset investment
is the Risk Adjusted Discount Rate. The RADR Elijelly (2004) viewed as, varying the
discount rate, keeping in view the degree of risk. It is that rate which accounts for risk
by varying the discount rate in line with the degree of risk of the investment. A
higher rate will be used for riskier investment while lower rates will be used for
investment with lesser risk. In order words, if the time preference for money is to be
recognized by discounting estimated future cashflows at some risk free-rate to their
present value, then to allow for the riskyness of those future cash flows, a risk
premium rate may be added to the risk free discount rate. Thus, if the risk free rate is
assumed to be 10%, an additional rate (risk premium), say 5% would be added to
compensate for the risk of the investment. Hence a composite 15% rate will thus be
used to discount the cash flow.
Although the RADR is simple and can be easily understood, it suffers some
shortcomings. The first is, the arbitrariness associated with the choice of the risk
premium rate. Warren and Fess (1996) posit, it may be possible to grade investments
into different risk classes and assign different risk premium rates; but every of such
categorization is based on hunch and intuition. Secondly, RADR does not make any
risk adjustment in the numerator of the cashflows that are forecasted over the future
years. Grayson in Pandy (2006) also argued that, though it is generally true that
investors are risk-averse, that there exist categories of risk seekers who do not
demand premium for assuming risks, and are willing to pay a premium to take risk.
Accordingly, the composite discount rate would be reduced not increased, as the level
of risk increases.
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3. Certainty Equivalent (CEQ)
The certainty equivalent procedure is another conventional method of dealing
with risk in capital budgeting. Under this method, an investor‟s „best estimate‟ is
reduced for certainty (Van Horne, 1998). That is, if an investor according to his best
estimate expects a cashflow of N200,000 from an investment, he will apply an
intuitive correction factor and may work with N160,000 to be on the safe side. In
essence, the decision maker establishes a coefficient of equivalent (represented as
COE or t) by assuming values of between 0 and 1. These coefficients reflect the
decision maker‟s confidence in obtaining a particular cashflow in period „t‟. The
COE approach recognizes risk in capital budgeting analysis by adjusting estimated
cash flows. Also by employing risk-free rate to discount the adjusted cashflows.
Consequently, it is seen as theoretically superior to the RADR approach as it
measures risk more accurately (Gordon, 2004). Although it is assumed a superior
approach, it suffers the same problem of arbitrariness. The procedure for reducing the
forecast of cashflows is implicit and likely to be inconsistent from one investor to
another, Gordon further stated.
4. Sensitivity Analysis
It is true that several factors (variables) are considered in the estimation of
cashflows. For example, forecasted cashflow depends on the expected revenue and
expected revenue is a function of sales volume and unit selling price. Similarly, sales
volume will depend on the market size and the company‟s market share. However,
costs moreso variable costs are dependent on sales volume, unit variable cost and the
fixed cost. Hence, the NPV or IRR of an investment is determined by analyzing the
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after tax cash flows arrived at by combining forecasts of these various variables. It
then implies that, the reliability of the NPV or IRR , or even the PI of an investment,
will depend on the reliability of the forecast of these variables underlying the
estimation of cashflows. In other words, to determine the reliability of an
investment‟s NPV, IRR or other investment analytical techniques, one would be
required to work out how much difference it makes, if any one of these forecasted
variables go wrong.
Pandy (2006:250) opined, one can change each of the forecasted variables, one
at a time to at least three values (pessimistic, expected and optimistic) and under each
assumption, recalculate the NPV, IRR or others; to determine the impact of the
change on each variable to the NPV or IRR. The method of recalculating NPV or
IRR by changing each forecast he refers to as, sensitivity analysis. Thus, he defined
sensitivity analysis as, a way of analyzing change in the investment‟s NPV (or IRR)
for a given change in one of the variables, which the forecasted cash flow is based.
Pandy defined sensitivity analysis as a technique designed to measure the
response or change in the profitability of an investment, caused by changes in factors
that affect such investment‟s cash inflow. According to him, it is used in association
with the method of evaluation technique chosen, to obtain such information as: what
is the effect of a 10% decrease in selling price on the NPV, IRR, DPB, etc. of an
investment?; what happens to NPV or other evaluation criteria, if production cost
increases or decreases by 5%?; what is the effect of a larger or smaller change in the
demand for a company‟s product market share?; what will happen if the economic life
of an asset is short-lived two years to the forecasted life span?; what will be the effect
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of change in general price level to the chosen evaluation technique in application?;
and so forth.
To determine the effect of any of these changes outlined, sensitivity analysis
has to be conducted. Sensitivity analysis according to Drury (1992), follows the
following three steps:
1. Identification of all the variables which have influence on the project‟s
evaluation technique as chosen;
2. Definition of the underlying (mathematical) relationship between the
variables; and
3. Analysis of the impact of the change in each of the variables on the project‟s
chosen evaluation technique.
Consequently, the financial analysts, while conducting sensitivity analysis
computes the project‟s NPV or IRR for each forecast under the three assumptions
(pessimistic, expected and optimistic). This allows the analyst such opportunity as to
ask the above „what‟ and „if‟ questions. When answering the whole range of these
questions, risks are examined in relative terms, rather than attempting to quantify it.
If a smaller change in one variable (example, 5% change in price) results to a major
change (say about 25% change) in the NPV or IRR (the investment‟s profitability)
such variable is considered sensitive and very risky, other things being equal. In all,
insensitive investments are preferred to very sensitive ones, since a small change in
any factor would have substantial effect on the sensitive investments, thereby
changing the estimated profit of an investment to loss (Lucy, 2003).
The problem with sensitivity analysis according to Drury (1992) and Lucy
(2003) is that, it does not consider the effect of a combination of changes in various
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variables on the profitability of an investment. Also it does not provide information
on the probability of the occurrence of these changes. These changes in variables are
intuitively forecasted. However, sensitivity analysis provides management with
information about the sensitivity of a project to changes in different variables, hence
serves as a warning on the riskyness of an investment. It equally aid management to
identify areas where additional information are needed in other to improve on their
estimates by highlighting the effects of error in estimate of various variables.
5. Scenario Analysis
Scenario analysis was developed to check the major set back of sensitivity
analysis, which assume that variables are independent of each other. It examine the
risks of an investment by analyzing the impact of alternative combination of variables
called scenarios, on the project‟s NPV or IRR (Allen, 2006). In practice, the
variables, which are considered separately, using sensitivity analysis are interrelated
and may change investment‟s NPV or IRR in combination, and differently than when
separately evaluated. Take for instance, using any three of the scenarios as developed
by Pandy (pessimistic, optimistic and expected), it may be possible that when
production is increased, say from 10,000 units to 12,500 units (i.e. 25% increase) and
the selling price is reduced from N25.00 to N23.75 (i.e. 5% reduction); and an
aggressive advertising campaign is resorted to, thereby, increasing the unit variable
cost from N5.00 to N5.50 (10% increase), and with an increase in fixed cost, from
N220,000 to N253,000 (i.e. 15% increase), that these scenarios will generate a
positive NPV. But when a single variable say decrease in selling price is focused, a
negative NPV, which indicates rejection of investment, will be the case. In essence,
scenario analysis focuses on the effect of combination of variables (scenarios), on the
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investment‟s NPV, and as such, corrects the major defect of sensitivity analysis as a
conventional technique for risk analysis. Though scenario analysis is seen as quite
useful in understanding the uncertainty of the investment project, it does not reflect on
the probability of the change in these variables (Allen, 2006).
6. Simulation Analysis
Simulation analysis is the brain child of Monte Carlo, but the first author to
experiment its application in capital budgeting was David Hertz (Pandy, 2006).
Simulation analysis according to Hertz in Pandy (2006) considers the interactions
among variables and probabilities of the change in values. Thus, Hertz developed the
following four steps to simulation:
1. Identification of Variables that Influence Cash Inflows and Outflows: When a
company introduces a new product in the market, the variables that are
effected will include; market size, market growth, market share, product price,
variable cost, fixed cost, product life cycle, and terminal value, and has to be
identified.
2. Specify the Formulae that Relate these Variables: Revenue depends on sales
volume and price. Sales volume is given by market size, market growth, and
market share. Similarly, operating expenses depend on production, sales,
variable cost and fixed costs. Hence a formula that relates these variables has
to be specified.
3. Indicate the Probabilities Distribution for each Variable: Some variables
have more uncertainty than others, thus, the probability distribution of each
variable should be known. For example, it is quite difficult to predict price or
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market growth with confidence, but a probable value may make one more
certain.
4. Develop a Programme that Randomly Selects one Value from the Probability
Distribution of each Variable: The value as selected is used to calculate the
projects NPV.
The computer according to him generates a large number of such scenarios,
calculates NPV and stores them. The stored values are printed as a probability
distribution of the investment‟s NPVs, along with the expected NPV and its standard
deviation. The risk free rate should be used as the discount rates to compute the
investment‟s NPV. According to Dam (2005) since simulation is performed to
account for the risk of the investment‟s cash flows, the discount rate should reflect
only the time value of money. Simulation analysis though is a very useful technique
for risk analysis, its practical use is limited because of a number of shortcomings.
Such shortcomings Dam outlined to include:
1. The model being quite complex to use because the variables are interrelated
with each other, and each variable depends on its value in the previous periods
as well. Thus, identifying all possible relationships and estimating their
probability distribution is a difficult task.
2. The model helps in generating a probability distribution of the investment‟s
NPVs, but does not indicate whether or not, of the project‟s acceptance.
3. Just like sensitivity analysis, simulation analysis considers the risk of any
investment in isolation of other investments. It does not correlate the effect of
one investment on others. Even when it is known that the consideration of
portfolios of investment diversifies unsystematic risks. That is, a risky
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investment may have a negative correlation with the company‟s other
investments, and therefore accepting such investment may reduce the over all
risk of the company.
Constraints in the Effective use of Capital Budgeting for Investment Analysis
The problems that hinder effective use of capital budgeting for investment
analysis according to Lucy (2003), are graduated into two major classes namely:
1. That which is encountered in the development of the capital budgeting system;
and
2. That which is encountered while using the capital budgeting as developed.
Problems Encountered in the Development of Capital Budgeting System
The problems encountered at this stage according to Lucy include:
1. Management Judgment: Capital budgeting though as sophisticated as it is,
even with the application of statistical and other science related device, is still
not an exact science. It‟s success hinges upon the precision of the estimates.
Estimates are based on facts and managerial judgment. Managerial judgment
according to him can suffer from subjectivism and personal biases.
Conversely, the adequacy or otherwise of capital budgeting depends on the
objectivity and adequacy of the managerial judgment.
2. Continuous Adaptation: It has been proved that the installation of a perfect
system of capital budgeting is not possible, moreso as various techniques may
yield varied results. Business conditions change rapidly hence capital
budgeting programme shall continuously be adapted to reflect these changes,
which is no easy task. In the words of Drury (1992), the application of various
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methods of capital budgeting techniques coupled with the risk analytical
devices in every capital investment decision make capital budgeting a hectic
exercise.
Problems encountered while using Capital Budgeting as Developed
1. Implementation: A skillful prepared capital budgeting though how perfect,
will not by itself improve the managerial efficiency of an enterprise unless it is
properly implemented. One major problem with capital budgeting is the
understanding of the sophisticated tools (mathematical and statistical) as is
used in the budgetary exercise. For capital budgeting to succeed, it is essential
that all the stakeholders understand it. Also, that the managers and
subordinates put concerted effort in accomplishing the budget goal or goals.
Developing an effective and efficient capital budgeting is one, and giving it
meaning through simplification for the understanding of all the stakeholder in
the implementation process, often had posed a problem (Dorotnisky, 2008).
2. Management Complacency: Capital budgeting like every other budgetary
process is a management tool (i.e. a way of managing), not the management.
The presence of capital budgeting should aid management achieve results but
should not replace management. According to Welch (2002), an onerous task
of managing and management hinges on intelligent use of capital budgeting
with foresight, else a well-developed capital budget may turn a mirage.
3. Goal Conflict: The purpose of capital budgeting will be defeated if carelessly
set budget goals conflict with the company‟s objective. This confuses means
with end results hence constrains the use of capital budgeting in investment
analysis. Capital budget goals should focus the definite target of achieving the
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overall company objective. It must be in harmony with the company‟s overall
goal.
4. Evaluation Deficiencies: Each capital budgeting evaluation technique has its
shortcomings and which the capital budgeting package hides. There should be
continuous evaluation of actual performance as to reveal such shortcomings
for action.
According to Wild, Larson and Chiappetta (2005), the difficulty in the use of
capital budgeting for investment analysis revolves around predicting events that will
not occur until well into the future. They further stated that many of these predictions
are tentative and potentially unrealistic. In other words, a capital budgeting decision is
risky and may be constrained by such factors as, the uncertainty of the outcome; the
extent of amount of money involved; the long period of commitment of such fund; the
sophistication of the evaluation techniques and risk measurement devices; and the
irreversibility, or reversal at huge loss, of any capital decision made.
Graham and Harvey (2001), Welch (2002), and Brounen and Kosdijk (2004)
subscribed to inflation as the major constraint in the effective use of capital budgeting
for investment analysis moreso in the developing economies of the world. According
to Graham and Harvey, the economy of most third world countries is unstable and
because the degree of accuracy in prediction is dependent upon the stability of the
economy, prediction is usually marred. And since the purchasing power of money
remains anything but constant in time of inflation, the soundness of an investment
decision applying the discounted cashflow techniques are bastardized.
However, Philippalys (2003) opined that no factor constrain effective use of
capital budgeting in investment analysis more than the risks and uncertainties inherent
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in most economies. He stated that, the whole process of investment analysis centres
on the inability of the decision maker to make perfect forecast of risk. The
implication is that, forecast cannot be made with perfection or certainty since future
events on which they depend on are uncertain. An investment may not be regarded as
risky if one can specify a unique sequence of cash flows. And if cashflows can be
specified or forecasted with precision (certainty), then the whole lot of investment
analysis trouble would not have arisen in the first place, Philippalys further argued.
In other words, risk arises in investment evaluation because we cannot predict the
occurrence of the possible event with certainty; and consequently, cannot make any
precise or absolute prediction about cashflow sequence. Thus, it becomes quite
difficult to effectively utilize capital budgeting for investment analysis without
analyzing the uncertain economic conditions. Risk to a large extent constrain the
effective use of capital budgeting and could bastardize the wealth base of a company
if its investment analysis are improperly handled.
Strategies for Improving on the use of Capital Budgeting
Capital budgeting otherwise referred to as investment appraisal, is the
planning process used to determine whether a company‟s long term investments such
as new machinery purchase or replacement, new plant purchase or replacement,
investment in new product line, and research and development projects are worth
pursuing. It is a budget for major capital, or investment expenditures, hence takes
care of all investments in long term projects (Akinsulire, 2010). Suffice it to say that
care must be taken to be able to choose intelligently between alternative projects as
mistakes made may cost the company its existence as has already been cited of
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Lockhead‟s production of L-1101 Tri-Star Commercial Jet. In essence efforts should
be made by the financial managers to avoid this doom, hence influence the company‟s
growth possibilities through efficient capital budgeting.
Graham and Harvey (2008) opined, since capital budgeting requires the
commitment of a great deal of the company‟s resources, adequate care must be taken
both in the selection and use of the investment appraisal techniques. To this end, one
may invariably suggest that the first strategy for improving on the use of capital
budgeting for investment analysis is careful selection and use of the investment
appraisal techniques. In a related view, Dugdale and Jones (1995) stated that,
companies would benefit immensely in terms of improved quality of decision making
if capital budgeting decisions are taken in the context of its overall corporate strategy.
Hastie (1984) argued that, though capital budgeting evaluative techniques are
important, that its sole use in deciding the capital expenditure to undertake may be
unreasonable and counter productive. To improve on capital budgeting for
investment analysis, the strategic considerations of management in capital
expenditure planning and control is of immense importance. This strategic
consideration is a systematic approach with which a company that is properly
positioned in a complex business environment balances its multiple objectives
through a systematic decision process. The emphasis here is that, in trying to achieve
a dependable capital budgeting decision, companies should adopt the capital
budgeting decision making process. This is because; it streamlines the stages and
possible responsibilities of the management in the decision making process and
control. Though this decision making process has earlier being elaborated, it is
pertinent that the stages be mentioned. They include: identification of the company‟s
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objectives; search for investment opportunities; identifying the possible future
environments (states of nature) that might affect the investment‟s outcome; listing of
the possible outcomes of each state of nature; measurement of payoff; selecting
investment projects to be embarked upon; obtaining authorization and subsequent
implementation; and review of capital investment decision or decisions. Hastie
concludes that, though strategic management consideration is vital, for capital
budgeting to positively affect investment decisions, strategic management
considerations should be sharpened with capital budgeting evaluative techniques.
Also, it should take into consideration the adoption of the decision making process
and in sequence as is indicated.
In a similar view, Elumilade, Asaolu and Ologunde, (2006) outlined the
processes en-route efficient use of capital budgeting for investment analysis to
include: i) identifying possible investment projects – originating project ideas more so
by line managers, and which must be continuous and repetitive; ii) identifying
possible alternatives to the projects being evaluated; iii) acquiring relevant data on the
projects under consideration; iv) evaluating the projects from the data assembled –
carrying out financial evaluation of the projects based on the criteria the firm uses,
and with the view that the use of more than one criterion is advisable; v) project
selection – the decision making stage where the board of directors usually take
decision on preferred project or projects; vi) project implementation – the action
stage where the project or projects so selected is/are undertaken; vii) project
monitoring and control – monitoring the progress of the project as implemented to
assess its effectiveness/benefits or otherwise, and recommending continuity, review
or post audit. They further stated that time preference and risks are intriguing ideas
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that decision makers cannot avoid in financial forecasting and decision making. As
such, to strategize for efficient capital budgeting, financial managers should recognize
time value for money, apply several investment evaluation criteria to select projects,
interprete investment appraisal techniques to management, and induce stakeholders to
categorize financial managers‟ functions as distinct from management functions.
These are adduced will increase the shareholders wealth base, thus yield a rate of
return larger than the normal rate; because the normal rate is earned if the owners
have invested in an alternative venture.
Pike (1992) is of the opinion that, since different investment evaluation
techniques may choose different projects, it is important that no one technique be
applied at a time in choosing investment project. Also, that a capital investment
reporting system be applied to review and monitor the performance of each technique
as applied to improve on future forecasts. This view is suggestive of the fact that,
though no one method of investment evaluation technique should be applied in
reaching investment decision, which a follow-up comparison of the actual
performance with the set standard is of utmost importance.
Similarly, Akinsulire (2010) advocated that one must watch out for the
following items of pitfalls while using the DCF techniques to select investment
projects. They are, Depreciation (which is an accounting derivation and does not
involve the physical movement of cash and should be disregarded); Interest (as the
essence of compounding and discounting is to account for time value of money,
allowing interest during computation for DCF will amount to double counting); Sunk
Costs (these are historical costs and represents amounts that has already been incurred
prior to the investment under consideration, hence should be considered irrelevant);
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Overhead Recovery/Absorption Rate/Fixed Costs (these are irrelevant costs except
when they are incremental in nature); Opportunity Cost (this represents an income
foregone and is not relevant); Working Capital (should be treated as an outflow in
year 0 and recovered in full at the end of the project‟s life); Incremental Cash flows
(only amounts with which the current earnings and costs will increase is considered
relevant); Relevant Year (cash flows arising at the beginning of a year are treated in
the previous year and irrelevant); and Existing Asset (market estimate of existing
assets are treated as out flows in year 0 and its scrap value as an inflow at the end of
the projects life). Akinsulire further stated that, management accountants are
beginning to accept the need for a more external orientation and a consideration of the
long term effects of investment appraisal generally, and particularly in organizations
that operate in rapidly changing markets. Hence charged financial managers to
combine formal and informal procedures, as well as short term and long term
considerations, to sustain effective capital investment appraisal.
Nolon (2005) itemized possible procedures for improving on capital budgeting
decision to include, combining statistical and conventional risk adjusted techniques in
selection of investment projects; applying risk adjusted techniques to investment
evaluation techniques when analyzing investment decisions; using cash flow and not
profit for DCF computation; and adhering strictly to the use of the company‟s policy
manual. Following this procedures conscientiously he affirmed will improve the
quality of capital budgeting decision in the context of its overall corporate objective.
This view of Nolon is suggestive of the fact that, though investment evaluation
techniques are vital instrument for project selection, other techniques and instruments
(statistical, non statistical, and risk adjusted techniques, and company‟s policy
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manual) must not be disregarded, more so in an unstable investment environment of
Nigeria.
In the views of Earl (2001), for company‟s survival in the face of competition
and for growth and development, such a company needs constant flow of ideas for
new products, new investment evaluation criteria, improved products and procedures
to achieve maximum output with minimal cost. To achieve these, an informed
company does not rely solely on its human resources. It must have to outsource
where necessary, thus allocate its resources to investments under sound concept of
divisional and corporate strategy. The validity of this view may be seen manifest in
business procedures which continually arouse the interest of experts in making
positive contributions required to compare the financial conditions and performances
of various companies. It is already a known fact in organizations that though the
financing apparatus of a company, it has been often difficult to acquire all its human
and material resources as may be needed to perform all its activities to meet the
market demand. What next? The companies that are better informed engage in
activities which it posses economic advantage, and sub-let/outsource others to expert
providers to achieve efficiency.
However, it should be of note that outsourcing has to be carried out with
utmost caution due to its inherent risk complexities. Gartner (2004) outlined three
guides to effective outsourcing. They include: determining which task to accomplish
in-house; determining that which should be accomplished through strategic
partnership; and determining that which should be contracted to the third party
specialist. It should be reiterated that the core company‟s tasks/activities must not be
outsourced. Earl (2001) in a similar view asserts, that a company that must outsource
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has to be aware of the related risks and threats, and plan well on how to overcome
them when it occur, to reap the benefits of outsourcing. In all, though outsourcing is
a vital emerging management strategy for improving on the use of capital budgeting
for investment analysis, management has to thread with caution while applying it.
Capital budgeting integrates the various elements of the company. Though its
administrative control rests with the financial manager, the effectiveness of the
company‟s capital investment/expenditure is dependent on the overall inputs of all the
major departments. Every department of the organization helps in the estimation of
the operating costs, and also in the estimation of initial outlay or investment costs.
The marketing department helps in providing sales forecasts; the purchases
department determines costs and sets specifications; while the finance department
procures and disburses funds and estimates their costs. In essence, the various
estimates of the other departments are drawn together by the finance department in
the form of project evaluation report, while the top management ultimately sets the
standards for acceptability. The major area of emphasis here is that, in as much as it
is the financial manager‟s responsibility to produce the project evaluation reports, he
should be offered a place in setting the standard for project acceptability (Osaze,
1996). However, recent studies in capital budgeting decisions indicates that financial
managers contributions forms part of the major emphasis for setting the standard for
project acceptability by top management. Top management of the 21st century
company‟s make it possible the combination of strategic considerations, discounted
and non discounted cash flow criteria, and even linear programming in choosing the
optimum alternative projects for implementation (Osaze,1996; Bruner, 2002;
Elumilade, Asaolu, and Ologunde, 2006; Wild, Larson, and Chiapptta, 2005; and
Akinsulire, 2010).
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Figure 4: Schematic Representation of Conceptual Framework
COMPANY MANUFACTURING
MANUFACTURING COMPANY
CAPITAL INVESTMENT BUDGETING
INVESTMENT ANALYSIS
CAPITAL BUDGETING
UTILIZATION OF CAPITAL BUSGETING FOR INVESTMENT ANALYSIS
CAPITAL BUDGETING
DECISION PROCESSES
CAPITAL BUDGETING
TECHNIQUES
INVESTMENT
EVALUATION
CRITERIA
OUTSOURCING
CAPITAL
EXPENDITURE
DECISION
CONSTRAINTS TO EFFECTIVE
CAPITAL BUDGETING
STRATEGIES FOR
IMPROVING ON CAPITAL
BUDGETING
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The schema as represented above entails that a company as formed has an
ultimate purpose, to manufacture goods. Thus manufacturing company converts raw
materials and component parts into consumer or industrial goods. This process
cannot be possible without capital, and the provision of capital brings two major
factors to the fore – investment and budgeting. Planning of investment is what is
referred to as budgeting. While capital budgeting discusses company‟s investment in
capital assets. In essence, capital budgeting is often utilized to evaluate investment in
capital assets. Evaluation of investment in capital assets refers to investment analysis.
Hence, capital budgeting is used for investment analysis. The utilization of capital
budgeting for investment analysis in manufacturing company entails using capital
budgeting decision process to aid corporate planning, management complying with
the use of capital budgeting techniques, using capital budgeting investment evaluation
criteria for investment analysis, and outsourcing capital expenditure decisions where
necessary to achieve effective capital budgeting. Though the use of these capital
budgeting measures will enhance investment analysis of manufacturing companies,
some constraints abound which affects its use thereby negating the essence of capital
budgeting. These constraints are checked by the strategies for improving on capital
budgeting and may result to referring back to the analysis stage.
The arrow lines linking the various loops indicate the relationship between the
concepts. The arrow head indicates the direction while double arrow heads signifies
continuity. In summary, it takes a company and manufacturing to form a
manufacturing company. A manufacturing company when formed is often for a
purpose, investment. Investment connotes provision of capital and budgeting for its
use (capital budgeting). The whole process of capital budgeting aims at improving on
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investment to boost the earning capacity of the company. When the use of capital
budgeting does not meet this objective, the financial managers goes back to the
drawing board.
Theoretical Framework
Quantity Theory of Money
The quantity theory of money is an important rationale for this study. The
quantity theory of money according to Boland and Pondy (1983) and Govindarajan
and Anthony (2004) is significant in the management and use of capital. The quantity
theory of money was propounded by Irving Fisher in 1911. The theory states that
money is held essentially for the purpose of bridging the time interval between known
receipts and known expenditures. According to Agba (1994), the quantity theory of
money places limit on accumulation and disbursement of money capital. In essence
the fore knowledge of the expenditure to be embarked upon and the estimated capital
to be employed to accomplish such tasks is very vital to the corporate existence of
every manufacturing company. This theory is specifically significant in this study as
the future destiny of every manufacturing company lies on efficient allocation of its
scarce resources, capital.
Liquidity Premium Theory
Capital is a discrete variable and as such, is not measured over a given period,
rather at a given or discrete time (Okafor, 1983). This special characteristic of capital
presupposes that it is not stored like every other product, which is stored in its original
state, rather it is invested to appreciate. The liquidity premium theory otherwise
referred to as the expectation theory postulates that investors expect always that yields
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on capital stock increase overtime (Pandy, 2006). This theory is part of the Keyness
liquidity preference as contained in his general theory, first published 1936. This
theory is synonymous with the scriptural verse of the man that entrusted his capital to
his servants while on a journey (Matt. 25:14-30). The servant that stored his share in
the ground for complete safety because he was afraid of investing it was labeled
wicked and slothful. In essence, while more capital was being allocated those that
invested and made returns, the little the slothful servant has was taken away from him
because of his unwillingness to make effort (invest). The application of this theory to
the present study revolves around timely investment of company‟s resources on
capital asset in order to maximize its wealth base.
Arbitrage Theory of Capital Assets Pricing
The predetermination of investment returns before venturing into it keeps
manufacturing companies on track, in the choice of investment. The Arbitrage theory
of capital assets pricing as developed by R.A. Ross in the year 1976 states that,
investors always indulge in arbitrage whenever they find differences in the returns of
assets with similar risk characteristics (Govindarajan and Anthony, 2004). It is
against this background that investment with higher yielding returns is often preferred
to that with lower returns when once their risk characteristics are the same. It then
imply that, though the risk nature of investments make investors differ in their
investment decisions, most investors are risk averse. A risk averse investor is that
who will choose from investments with equal rates of returns, that with the lowest
standard deviation, or whose risk is lower. The decision to invest is an onerous task
because of the uncertainty nature of future events, which is synonymous with every
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class of investment. The tagged slothful servant may actually be willing to invest, but
due to his unwillingness to take risk, he resigned to fate. In essence, the motive to
invest depends largely on the risk preference of the investor.
Utility Theory
In the year 1955, Neuman and Morgenstern developed the utility theory
(Pandy, 1998) and subsequently, the risk preference theory (Eugene,1995). The Risk
Preference Theory states that, investors generally prefer to invest in projects with high
rates of return and lower standard deviation; while the utility theory aims at
incorporating the decision maker‟s risk preference explicitly into the decision
procedure. Hence, it postulates that, a rational decision maker would maximize his
utility, thus will accept the investment project which yields maximum utility to him
(Eugene, 1995). These theories run at congruence with the economic principle of
Diminishing Marginal Utility. The economic principle of Diminishing Marginal
Utility according to Aurt (1983:23) states that, „as a person gets more and more
wealth, his utility for additional wealth increases at a declining rate‟. This means that,
one may obtain less utility from gaining additional N1,000, than he forgoes in loosing
N1,000. Consequently, the decision maker‟s choice would depend upon his risk
preference as it is always difficult to say whether a decision maker should choose a
project with a high expected value and a high standard deviation; or a project with a
comparatively low expected value and a low standard deviation.
The rationale for these theories is that investors do not make investment choice
basing all alone on rate of return. The risk nature of every investment counts a lot; as
the risk nature of a project may turn its profitability to the negative (Pike, 1992).
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Hence, most investments which yields very high rates of returns are highly risk prone.
That is, the higher the rates of returns, the higher the rate of risk inclined to such
investment. Thus, the major reason behind the risk aversiveness nature of investors.
Though, often than times, the risk attitude of some investors counters the risk
preference theory. A risk-neutral investor does not consider risk, and would always
prefer investments with higher returns though the risk magnitude of such investment
(Van Horne, 1998). The risk-seeking investors would like investments with higher
risks irrespective of the rates of return; as often, very risky investments dispel
investors (Osaze, 1996). In all, „in practice most investors are risk averse‟ (Pandy,
2006:257). From the foregoing, and based on expected values or expected rates of
returns and standard deviations for analyzing risks in capital budgeting, it is difficult
to affirm that an investor or a financial analyst will choose a project with a high
expected value and a high standard deviation, or that with a comparatively low
expected value and a low standard deviation. Though financial analysts are in
agreement that the decision makers choice would always depend upon his risk
preference, the attitude of individuals and firms in handling risks contrast this view;
hence the need for the utility theory.
Portfolio Investment Theory
The riskyness of projects according to Brealey, Myers and Macus (1995), gave
birth to the portfolio investment theory. The portfolio theory as developed by
Markovitz, H.H. in the year 1959, provides a normative approach to investors to make
decisions to invest their wealth in assets or securities under risk. It states that,
„investors hold well-diversified portfolios instead of investing their entire wealth in a
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single or few assets‟ (Brealey, Myers, and Macus 1995:316). An important
conclusion to be drawn here is that, if investors hold well diversified portfolio of
investments, then their concern should be the expected rate of returns on the portfolio,
rather than on individual asset, project or investment; also the contribution of
individual investment to the portfolio risk. Hence, a basic assumption of this theory is
that, the returns of assets are normally distributed. That is, the mean (expected value)
and the variance or standard deviation analysis, stands the foundation on which the
portfolio decision is based. It is from this portfolio theory that the framework for
valuing risky projects, the Capital Assets Pricing Model (CAPM) was derived.
At this juncture, it may be pertinent to point out the fact that, though the
perfectness as may be assumed in selecting an investment project, one would have to
think of the outcomes of returns under possible economic scenarios to arrive at a
perfect judgment about the expected returns. In other words, to base investment
decisions on returns alone may be deceitful but may be more certain when considered
under various economic variables. The classical probability theory assumes that, no
statement or decision whatsoever can be made about the probability of any single
event (Francis, 1998). That is, no decision can be made with precision or certainty
about the occurrence of any one event. This is irrespective of the fact that most
crucial information for capital budgeting decision is a forecast of future cashflow
which is a single figure, usually referred to as „best estimate‟ for the period.
The classical theorists (David Hume, Iving Fishing, A.C. Pigou, A. Marhsal, J.
Tobin, J.M. Keyness, W.J. Baumol, Milton Freidman and Karl Brunner) opine that
one can talk about probability in a very long-run sense, given that the occurrence or
non occurrence of the event can be repeatedly observed over a very large number of
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times under independent identical situations (Francis, 1998; Mullins, 1982; Copeland
and Weston, 1983). Thus, the probability estimate, which is based on a very large
number of observations, is known as objective probability, they further stated.
The classical concept of objective probability is of little use in the analysis of
investment decision; as investment decisions are non repetitive and is hardly made
under independent identical conditions overtime (Mullins, 1982). According to
Copeland and Weston (1983), objective probability is not very useful in expressing
the forecasted estimates in terms of probability. However, in recent years, another
view on probability theory, the personalistic theory of probability was developed by
the classical theorists (Gordon, 2004). The personalistic theory of probability
according to Gordon holds that, it makes a great deal of sense to talk about the
frequency concept when analyzing investment decisions. In other words, the theory
assumes that, it is perfectly valid to talk about the probability of a single event (the
sales reaching a specific level next year; a particular rate of return being reached after
the trading period; or the probability that earnings per share will exceed N5.00 next
year). Such probability assignments that reflect the state of belief of an investor or
person, other than the evidence of a large number of trials is known as personalistic or
subjective probability; and very crucial in the analysis of investment decisions
(Brealey, Myers, and Marcus 1995; and Gordon, 2004).
Dominant Theory of Budgeting
According to Matz and Usry (1996), a budget is a plan quantified in monetary
terms prepared and approved prior to a defined period of time usually showing a
planned income to be generated, and or expenditure to be incurred during that period,
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and the capital to be employed to attain a given objective. Thus, a budget is an
objective statement of intended action plan, which is non-repetitive and are hardly
identical overtime, even with identical investment decisions. According to Leloup
(1998), budgets changes with investment, economic conditions and overtime. Suffice
it to say that, budget changes overtime and in consonance with the state of belief of
the investor, the risk nature of the investment notwithstanding. This changingness,
which should be timely to reflect the desired change, contrasts Wildavsky‟s dominant
theory of budgeting of the 1960‟s, referred to as the normative theory of budgeting.
The theory states that, budgeting would be a comprehensive political theory detailing
what the government‟s action ought to be over time (Fennon, 1965). This view
according to Fennon made „incrementalism‟ become the dominant theory of budget in
the United States where much literature in budgeting emanated.
Incrementalism as a style of policy making based on small marginal changes
from existing policies contends not only that comprehensive rationality is impossible,
but also that policies are seldomly changed radically as a result of extensive reviews.
It is the tendency of the government to thinker with policies rather than to question
the value of continuing them (Wildavsky, 1964:236 in Van Horne, 1979:163).
Considering the work of Wildavsky, budget process was seen as stable, predictable,
changing little from year to year and based on a well-defined role that could be
represented by relatively simple decision rules (Fennon, 1965; Horne, 1979). They
argue that, a process which concentrates on an increment is preferable to one that
attempts to review the whole budget because it moderates conflict, reduces search
costs, stabilizes budgetary rules and expectations, and reduces the amount of time that
officials must invest in budgeting.
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By the late 1970‟s, incrementalism was seriously challenged as a theory of
budgeting (Leloup, 1998) because of the narrowness of its analytical focus and
changes in the environment and processes of budgeting. Leloup viewed that, when a
theory applies to all situations at all times without the possibility of disconfirming
evidence, it is no longer a theory and of little use for explanation or even description.
As economic and social intervention of individuals, firms and governments have
increased, the limitations of incrementalism as a budgetary practice became
increasingly apparent. A number of techniques and attempts to reforming budget
systems were introduced to make decisions more rational. A key development in
budget theory has been the differentiation between micro-budgeting and macro-
budgeting; and the inherent tension between them. Leloup (1998) defined macro-
budgeting as high level decisions on spending, revenue and deficit aggregates, and
relative budget share, often made from top to down. Micro-budgeting he sees as
intermediate level decisions on agencies, programs, and line items, usually made from
the bottom up.
Both levels of analysis are interested in how power is structured in budgeting
processes as well as being exercised and expressed through budgeting choices. The
basic conceptualization of budgeting has shifted from a cycle of micro-level
incremental executive requests and legislative actions to a complex series of policy
responses, and short – term economic changes and projections which allows for a
level playing ground for both the executive and the line managers in budget issues.
This has changed budgetary focus from non-participatory to participatory budget.
Participatory budget referring to that, which is prepared with the active participation
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of middle and lower level managers who are responsible for their individual budgets
(Nweze, 2004).
The miracle of participatory budget is buttressed in Genesis 11:1-9… And
they said to one another, come on! Lets make bricks and bake them hard,… and build
a city with a tower that reaches the sky, so that we can make a name for ourselves and
not be scattered all over the earth‟. The major success achieved here was due to
oneness of intent. All the stakeholders right from the planning stage down to
implementation (the building of the tower) participated and fully. The implication of
this religious theory is that every stakeholder in the budget implementation should be
involved in budget preparation. And because a budget is essentially a bench mark for
a company‟s performance, its execution is regarded most successful when every
stakeholder has participated in the preparation (Dam, 2005), as each manager with
budget responsibility have an opportunity to explain and define their respective
budget proposals, (Nweze, 2004).
Related Empirical Studies
Few empirical studies have been conducted in the area of the present study.
Nnoli (2004) conducted a study on appraising capital investment decisions for small
scale industries in Nigeria, a case study of some selected small scale industries in Port
Harcourt, Enugu, Owerri, Aba and Onitsha. The population of the study comprised of
57 small scale industries that engage in pure water, bakery, poultry production, and in
the manufacture of clothing and chemical products. He adopted a survey design. The
major purpose of the study was to examine and appraise capital investment decisions
as is used by small scale industries in the major cities of southern Nigeria (South-
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South and South-Eastern cities). It was found out that: 1) there is a positive
relationship between capital investment project appraisal and the viability of small
scale industries; 2) the viability of projects are based on the reports of the feasibility
studies that are conducted; 3) investment appraisal techniques form the bedrock of the
feasibility studies that are conducted; 4) most of the small scale industries conduct
feasibility studies before they embark on capital investment projects; 5) inflation and
taxation do not impact or affect the investment appraisal for capital investment
decisions. The present study is related to Nnoli‟s study in that both focus the
assessment of capital investment decisions of industries. However, the previous study
was on small scale industries across some selected south Eastern states of Nigeria
while the present study centred on manufacturing companies in Enugu and Anambra
states. Also, while the previous study was examining the extent small scale industries
appraise their capital investment decisions, the present study focused on the extent
manufacturing companies use capital budgeting for investment analysis.
Oyedele (2007) who also adopted a survey design conducted a study on
budgeting and budgetary control: tool for economic development of small and
medium scale industries in Rivers state of Nigeria. The population of his study
comprised of 80 Accounting staff of 39 small and medium scale industries in Rivers
state. The major purpose of the study was to determine whether budgeting and
budgetary control serve as a tool for economic development of small and medium
scale industries. It was found that budgeting and budgetary control procedures in
small and medium scale industries have not quite attained a sufficient level to
enhance total accomplishment of the industry‟s objectives; and that small and
medium scale industry‟s success was not as a result of corrective actions taken when
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budget variance exist, rather as a result of proper planning and control of budgeting
and budgetary practices. The present study is related to Oyedele‟s study in that both
discusses budget and budgetary practices in Nigerian companies. Conversely, the two
studies differ in that while the present study focused an aspect of financial budget as a
tool for optimum investment analysis, Oyedele‟s study was on budget (both operating
and financial) as a tool for economic development of small and medium scale
industries.
Enweluzor (2006) studied assessment of capital budgeting techniques and
model and its effect on organisations profitability: an accountant approach, a case
study of WINCO foam manufacturing firm, Anambra state. 40 accounting officers
were used for the study. The major purpose of the study was to observe and assess
capital budgeting techniques and models, and its effect on company‟s profitability. It
was found that: 1) company‟s profitability is influenced by the capital budgeting
model adopted; 2) discounted techniques are preferred to non discounted techniques;
3) capital revenue and profit are related as while capital revenue is entirely charged to
profit, capital expenditures are not; 4) Nigerian companies do not assign capital
budgeting full time to a staff but to a committee when faced with such decision; 5)
NPV technique is the most widely used amongst Nigerian companies. The present
study is highly related to this study in that both focused the use of capital budgeting
by manufacturing companies. Consequently, Enweluzor‟s study assessed the
influence of capital budgeting on manufacturing company‟s profitability.
Specifically, the major areas of difference include: 1) the present study cuts across
various classes of manufacturing companies whereas Enweluzor‟s study was on one
manufacturing company, WINCO; 2) the present study assessed the degree of
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management‟s compliance with the use of capital budgeting as an investment
analytical tool, Enweluzor‟s study concentrated on the effects of capital budgeting
techniques in application on company‟s profitability; 3) the present study will use
frequency counts, percentages and mean in its analysis, Enweluzor‟s study used
simple percentage.
Ugwuanyi (2006) adopted a descriptive survey design to carry out a study on
the relevance of budgeting and budgetary control in manufacturing companies, a case
study of Nigerian Bottling Company Plc, Enugu. The population of the study was
190 staff of Nigerian Bottling Company Plc, Enugu. The major purpose of the study
was to assess the relevance of budgetary control in manufacturing companies. The
principal findings of the study among others were: 1) that budget serves as an
effective means of planning business activities; 2) that budget variance which occur
in the course of budget monitoring are analyzed and used as a corrective measure for
future planning; 3) the responsibility holders are often not allowed to continuously
control their units‟ budget, especially in turbulent business years; 4) efficient
budgetary control leads to improved business activities; 5) the major problem
encountered by the company in the budgetary control activities is the
misunderstanding of the essence of budgetary control measures by some functional
managers. The present study and Ugwuany‟s study are related in that both focus
budgets, moreso as Nigerian Bottling Company Plc will be one of the large scale
multi-national manufacturing companies the present study will conduct its research
on. However, their differences lies in the following: 1) the present study is on
different classes of manufacturing companies while Ugwuany‟s study is on one large
multi national manufacturing company; 2) the present study will deal extensively on
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the use of capital budgeting to assess and select viable investment projects,
Ugwuanyi‟s study was on the budgetary systems as is applied and its control to
enhance business activities. Consequently, Ugwuany‟s study was conscious of
management‟s use of budget variance to improve future business plans and actions.
Okoroji (2008) carried out a study on activity based budgeting: profit
management analysis tool; a case study of Nigeria Bottling Company, Port-Harcourt.
The researcher adopted a survey design, and used 25 Accounting staff of Nigerian
Bottling Company for the study. The purpose of the study was to assess the impact of
activity based budgeting in profit management of companies. It was found out that
activity based budgeting could be a better budgeting technique as it increase the
viability of companies, also aids the separation of company‟s activities that add value
from that which does not. Hence, the determination and separation of value added
and value wasted activities is seen a better approach of analyzing and improving on
manufacturing company‟s profit. The present study is related to Okoroji‟s because
both focus on the use of an aspect of budget by manufacturing company to analyze its
investment activities. However, while the present study will discuss an aspect of
financial budget as an investment analytical tool, Okoroji‟s study centred on an aspect
of budgeting technique. In essence, while the present study concentrates on capital
budgeting, the financial manager‟s investment analysis tool; Okoroji‟s was on activity
based budget, management‟s profit analysis tool.
Imegi and Anamakiri (2004) conducted a study on appraising investment
decision and corporate performance of manufacturing companies in Port-Harcourt,
Nigeria, adopting a survey design. The population of the study comprised of 75
decision makers of private manufacturing companies and 60 decision makers of
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public manufacturing companies in Rivers state. The major purpose of the study was
to appraise investment decision criteria in relation to corporate performance of
manufacturing companies. The principal findings of the study were: 1) investment
decisions and environmental factors really influence corporate performance; 2)
manufacturing companies in Nigeria adopt the same (uniform) investment criteria in
assessing their investment; 3) analytical tools used by manufacturing companies do
not affect and influence their corporate performances; 4) ownership structure induces
the manner in which decisions are taken in any organization; 5) non discounted
techniques should not be used alone in calculating investment decisions; 6)
discounting techniques can be used but one method only will not give a faithful result.
The present study is highly related to Imegi and Anamakiri‟s study in that both
focused the use of discounted and non discounted investment decision criteria to
analyze investment decisions of manufacturing companies in Nigeria. However, the
first major difference between the present and the previous study was on the major
purpose of the study. While the present study‟s major purpose is to assess and
analyze the extent manufacturing companies use capital budgeting for its investment
analysis, Imegi and Anamakiri‟s, was to appraise investment decisions as already
made in relation to the company‟s corporate performance. Other ways in which the
present and previous study of Imegi and Anamakiri differs include: 1) the use of mean
and percentages in analyzing respondent‟s responses by the present study as against
the use of simple percentages by Imegi and Anamakiri; 2) the present study in
addition to analyzing the use of discounted and non discounted investment decision
criteria to determine investment project proposals, also assessed the investment
decision processes used in taking capital expenditure decisions which was not
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incorporated in Imegi and Anamakiri‟s study; 3) while the present study assessed the
extent to which outsourcing of capital expenditure could enhance the prospect of
manufacturing companies, Imegi and Anamakiri‟s study assessed the influence of
environmental factors on corporate performance.
The above differences between the present study and Imegi and Anamakiri‟s
study, and the 5 years gap between Imegi and Anamakiri‟s study and this study are
enough justifications for carrying out this study. The five-year gap is enough for
investment appraisal techniques for efficient investment decisions in manufacturing
companies to change, moreso in an ever changing economic milieu of Nigeria.
Summary of Related Literature
The literature reviewed indicates that corporate planning is very vital to
company‟s performance as it enhances estimation of future capabilities. It also
reduces perceived uncertainties thereby strengthening company‟s position to achieve
desired results. Most authors agree that financial planning is an integral part of
corporate planning, and that capital budgeting is a major yardstick for measuring a
company‟s corporate plan. Consequently, the attainment of every organizational goal
is dependent on the effectiveness and efficiency of such company‟s capital budgeting,
as erroneous forecast will tantamount to a serious threat to company‟s survival.
The literature reviewed equally indicated that management especially in the
developing nations fail to use capital budgeting techniques in analysing their
investment decisions due to the complex nature of the analytical techniques and its
computation; the shortcomings inherent in the application of anyone method; the high
rate of uncertainty factors (social, political and economic) that often make predictions
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fail. Though these shortfalls, it was generally agreed that the use of capital budgeting
techniques is significant especially when strategic parameters (market, product, price,
technology, competition etc.) that usually mar its use are considered and incorporated.
The literature reviewed also indicated that, though the use of capital budgeting
for investment analysis has proved one and a major approach a company could use in
order to invest its current funds most efficiently in the procurement of long term
assets (investments) that would maximize shareholders wealth base, Nigerian
manufacturers do not apply it often due to some impediments inherent in its
application. Even with the impediments, some of which the financial manager can
correct, if allowed full participation in the decision making, he is always a lone voice
in taking capital investment decisions, as his suggestions may or may not matter in
accepting or rejecting an investment proposal.
Most of the authors contend that outsourcing is a beneficial management
strategy, a practice of contracting out part responsibility or function which cannot be
properly handled in-house to an expert external provider. Outsourcing was generally
believed to have strengthened manufacturing company‟s competitive advantage in the
growing competitive pressures of globalisation and liberalisation. Even with the
merits of outsourcing, the authors contend that it must not be trivially handled, and
shall only be embarked upon when such task, function or responsibility does not
constitute such company‟s strategic function.
The literature reviewed also indicate that the decision making process is a
major method of balancing capital budgeting evaluative techniques with the
management corporate strategy to generate efficient investment project decision. The
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literatures reviewed succumb to capital budgeting techniques as have proved a major
reliable way of minimizing or obviating risks while analyzing investment decisions.
The various authors who studied budget dwelt on general budgeting and its
control for improving company‟s wealth base. Only one author studied capital
budgeting techniques and model and its effect on organisation‟s profitability. It did
not cover all aspects of capital budgeting neither did it discuss its use in investment
analysis and project selection. Also, the study that discussed investment project
appraisal using discounted and non discounted techniques only related it to the
appraisal of investment decisions as already taken, but not as selection criteria for
investment decisions to be made. It studied investment decisions and corporate
performance and did not cover the use of capital budgeting in investment analysis.
These gaps are what the present study intends to fill.
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CHAPTER THREE
METHODOLOGY
This chapter describes the procedures used in this study. The procedures
include, design of the study; area of the study; population for the study; sample and
sampling techniques; instrument for data collection; validation and reliability of the
instrument; method of data collection; and method of data analysis.
Design of the Study
The study adopted a descriptive survey design. A survey of managers and
accountants of the manufacturing companies in Enugu and Anambra States was
carried out to ascertain their opinion on the use of capital budgeting for investment
analysis in manufacturing companies. Survey research design is regarded suitable for
this study because the researcher aims at identifying the characteristics of a defined
population with respect to specific variables. According to Osuala (2005), survey
research focuses on people, the vital facts of people, and their beliefs, opinions,
attitudes, motivations, and behaviours. This research work adopted a survey design
because people‟s opinion was sought using questionnaire, and their views used to
justify the current practice, and consequently suggest better ways for improvement.
Area of the Study
The study was carried out in manufacturing companies in Enugu and Anambra
States of Nigeria. Enugu and Anambra States were chosen for the study because
though they have reasonable number of registered manufacturing companies, Eneh
(2005) observed incessant manufacturing failures in the area. It is pertinent therefore
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that this study was conducted in Enugu and Anambra States to minimize or obviate
future failures of manufacturing companies in the states.
Population for the Study
The population for the study was 552 management staff comprising of 4
management staff (managing director, accountant, internal auditor and the purchasing
manager) from each of the 138 registered manufacturing companies in Enugu and
Anambra States. Enugu State has 29 manufacturing companies divided into 3 rural
and 26 urban manufacturing companies; while Anambra State has 109 manufacturing
companies, divided into 3 rural and 106 urban manufacturing companies. The
distribution of the manufacturing companies and the respondents into senatorial
zones, and urban and rural areas were as follows: Enugu East, 1 rural and 25 urban
manufacturing companies; Enugu West, 2 rural manufacturing companies; Enugu
North, 1 urban manufacturing company; Anambra Central, 1 rural and 61 urban
manufacturing companies; Anambra North, 26 urban manufacturing companies; and
Anambra South, 2 rural and 19 urban manufacturing companies. The population
distribution was shown in appendix „D‟.
The four management staff from each of the 138 manufacturing companies
were the Managing Director, the purchasing manager, the accountant and the internal
auditor. These officers were used for the study because they are the principal staff
responsible for the implementation of capital budgeting in manufacturing companies.
Sample and Sampling Technique
The sample for the study was 84 manufacturing companies made up of 4 rural
and 80 urban manufacturing companies drawn from the population of the
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manufacturing companies. A total of 336 management staff, made up of 4
management staff (managing director, accountant, internal auditor, and the purchasing
manager) from each of the 84 manufacturing companies constituted the respondents.
The proportionate stratified sampling technique was used to draw the sample
of the study as follows: The manufacturing companies were stratified into 6 senatorial
zones, 3 each from the two states. Thereafter, the manufacturing companies per
senatorial zone were further stratified into rural and urban located manufacturing
companies. A proportion of 60 percent of both the rural and urban manufacturing
companies was randomly selected for the study. This amount to 4 rural and 80 urban
manufacturing companies, giving a total of 84 manufacturing companies, as was used
for the study.
The distribution of the sample of the manufacturing companies and the
respondents according to senatorial zones and urban and rural locations were as
follows: Enugu East, 1 rural and 15 urban manufacturing companies; Enugu West, 1
rural manufacturing company; Enugu North, 1 urban manufacturing company;
Anambra Central, 1 rural and 37 urban manufacturing companies; Anambra North, 16
urban manufacturing companies; and Anambra South, 1 rural and 11 urban
manufacturing companies. The sample distribution was shown in appendix „D‟.
Instrument for Data Collection
Structured questionnaire was used to generate the required data for this study.
The questionnaire contains 81 items that were divided into 8 sections, sections A – H.
Section A dealt with general information about the manufacturing companies and the
respondents. This section contained 4 items on general information about the
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company and the respondent with options to enable the respondents tick (√) or fill as
appropriate.
Section B contains 12 items numbered 1 to 12, and was used to elicit
respondents response on the extent to which capital budgeting processes were used to
aid corporate planning for long term survival of manufacturing companies in Enugu
and Anambra States of Nigeria. Section C dealt with research question 2. It contains
7 items numbered 1 to 7. The items were used to elicit the respondents‟ opinion on
the extent of management‟s compliance with the use of capital budgeting techniques
for investment analysis in manufacturing companies.
Section D dealt with research question 3. It contains 10 items, numbered 1 to
10. The items was used to obtain opinion of the respondents on the extent
manufacturing companies utilize capital budgeting investment evaluation criteria for
investment decisions in Enugu and Anambra States of Nigeria. Section E dealt with
research question 4. It contained 12 items numbered 1 to 12. The items were used to
elicit respondents‟ opinion on the extent outsourcing is utilized in taking capital
expenditure decisions in manufacturing companies in Enugu and Anambra States of
Nigeria.
Section F dealt with research question 5. It contained 7 items numbered 1 to
7. The items were used to elicit the opinion of the respondents on the extent to which
the use of capital budgeting techniques for investment analysis enhance
manufacturing company‟s earnings. Section G dealt with research question 6. It
contained 17 items numbered 1 to 17. The items were used to obtain the opinion of
the respondents on factors that constrain effective use of capital budgeting for
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investment analysis in manufacturing companies in Enugu and Anambra States of
Nigeria. Section H dealt with research question 7. It contained 13 items numbered 1
– 13. The items were used to obtain the opinion of the respondents on strategies for
improving on effective utilization of capital budgeting for investment analysis in
manufacturing companies in Enugu and Anambra States of Nigeria.
The questionnaire items for sections B – H were structured on a five point
Likert rating scale with response options of “very great extent or very much used”,
“great extent or much used”, “little extent or used on the average”, “very little extent
or rarely used” and “no extent or not used”.
Validation of the Instrument
The questionnaire was subjected to face validation by two Business Education
specialists from the Department of Vocational Teacher Education, University of
Nigeria, Nsukka; two Accounting specialists from Accountancy Department of
University of Nigeria, Enugu Campus; and one professional Accountant in the service
of the University of Nigeria, Nsukka. The researcher requested these specialists to
check the adequacy and correctness of the questionnaire items for the study. Their
suggestions, comments and observations were used to refine the final draft of the
questionnaire items.
Reliability of the Instrument
Cronbach Alpha reliability test was used to determine the internal consistency
of the instrument. The instrument was administered on 48 management staff made up
of 12 managing directors, 12 accountants, 12 internal auditors, and 12 purchasing
managers selected from 12 manufacturing companies in Delta and Abia States. Delta
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and Abia States were selected because they possess almost the same geographical and
business climate as the study area. Also to ensure that the subjects used in the
reliability test were excluded from the sample. Responses were obtained from the 48
respondents. Cronbach Alpha reliability coefficient was obtained for each of the 7
clusters and for the entire instrument. The Cronbach Alpha reliability coefficients of
each of the 7 clusters were 0.959, 0.953, 0.967, 0.932, 0.972, 0.940, and 0.984
respectively, with an overall reliability index of 0.958. The use of this reliability
method was regarded appropriate for determining the internal consistency of the
instrument. Internal consistency reliability measures yield of an information about
the precision of various items in an instrument in measuring the common underlying
phenomenon.
Method of Data Collection
Copies of the questionnaire were personally administered to the respondents
by the researcher with the help of two trained research assistants. The two research
assistants were trained on how to approach the respondents for easy acceptance and
return of the questionnaire. They were equally educated on the contents of the
questionnaire and the purposes of the study to enable them explain to the respondents
when the need arises. The researcher administered questionnaire in most of the
manufacturing companies used for the study. He covered Enugu State and Anambra
Central. A research assistant covered Anambra North Senatorial Zone, while the
second research assistant covered Anambra South Senatorial Zone of Anambra State.
In total, 336 copies of the questionnaire were administered to the respondents while
320 were retrieved; representing about 95% retrieval.
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Method of Data Analysis
The research questions were answered using descriptive statistics of Mean and
Standard Deviation. Values were assigned to the Likert scale response categories as
follows for the purpose of the Analysis:
Very Much Used/Very Great Extent takes boundaries of 4.50 – 5.0
Much Used/Great Extent takes boundaries of 3.50 – 4.49
Used on Average/Little Extent, 2.50 – 3.49
Rarely Used/Very Little Extent, 1.50 – 2.49 and
Not Used/No Extent, 0.50 – 1.49.
The Mean score and the Standard Deviation of each questionnaire item was
computed and interpreted. The Mean scores were interpreted based on the boundary
limits of the points assigned to each response category. Items with Mean values of
3.50 and above were accepted as a factor and regarded as much used or used to a
great extent. While items with Mean values of less than 3.50 were regarded as used to
a little extent.
The Standard Deviation (SD) as used was to measure the dispersion or
variability of the respondents‟ responses from the Mean. Large SD (SD of 1.0 and
above) shows that the scores are widely scattered above and, or below the Mean,
implying that the opinions of the respondents vary significantly from one another.
While small Standard Deviation (SD of below 1.0) shows that the scores are tightly
clustered around the mean, implying that the respondents do not differ much in their
opinion. Uzoagulu (1998) opined, if the Standard Deviation is large, say 1.0 and
above, then the agreement among the respondents on the issue is regarded as loose;
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but if the standard deviation is small, below 1.0, it implies that greater number of
people agreed on the issue.
Null Hypotheses 1 and 5 were tested using t-test statistic at 0.05 level of
probability and 318 degree of freedom (df), while analysis of variance ANOVA was
used for testing hypotheses 2, 3 and 4 at 0.05 level of probability. When the
calculated t-value was equal to or greater than the given (table) t-value, the null
hypothesis was rejected. Conversely, when the obtained t-value was less than the
given critical t-value, the null hypothesis was accepted. Also when the F-calculated
value was greater than the F-critical value of 3.00 at 0.05 level of probability, the null
hypothesis was rejected. The null hypothesis was accepted when the obtained F-
calculated value was less than the given F-critical value. On the whole, Statistical
Package for the Social Sciences (SPSS) version 16 was used to compute the generated
data.
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CHAPTER FOUR
DATA PRESENTATION AND ANALYSIS
In this chapter, data collected for the study were presented and analyzed in line
with the research questions and formulated hypotheses.
Research Question 1
To what extent does the use of capital budgeting decision processes aid
corporate planning for long term survival of manufacturing companies?
The items dealing with the extent to which the use of capital budgeting
decision processes aid corporate planning for long term survival of manufacturing
companies was answered using items 1 to 12. The responses to the items were
presented in Table 1 below.
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Table 1: Mean Ratings and Standard Deviations of Respondents on the Extent
the Use of Capital Budgeting Decision Processes Aid Corporate
Planning for Long Term Survival of Manufacturing Companies
S/N Item Statements X SD Rmks
1 Analyzing investment proposals in
capital assets 4.20 0.97 Great Extent
2 Analyzing departmental operations in
line with company‟s overall objectives 3.33 1.27 Little Extent
3 Estimation of investment‟s cash flow 3.41 1.47 Little Extent
4 Estimation of investment‟s required rate
of returns 3.66 1.03 Great Extent
5 Comparing expected future streams of
cash flows with immediate and past
streams
3.13 1.29 Little Extent
6 Conducting feasibility study on
investment proposal 4.14 0.94 Great Extent
7 Ranking investment proposals based on
appraisal and evaluation techniques 3.08 1.43 Little Extent
8 Capital rationing 3.64 1.38 Great Extent
9 Selecting investment proposal and
applying risk measurement devices 1.78 1.03 Little Extent
10 Timely selection of capital assets. 2.47 1.21 Little Extent
11 Monitoring of investment on capital
assets 2.17 1.19 Little Extent
12 Evaluating capital expenditure decisions
for remedial actions 2.27 1.13 Little Extent
Key: X = Mean
SD = Standard Deviation
The data presented in Table 1 showed that items 1, 4, 6, and 8 have Mean
values of 3.5 and above, indicating that the items aid corporate planning for long term
survival of manufacturing companies to a great extent. For items 2, 3, 5, 7 and 9 – 12
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with Mean values of below 3.50, the respondents felt that those items when used in
capital budgeting decisions would aid corporate planning for long term survival of
manufacturing companies to a little extent.
The standard deviation values for 10 out of the 12 items, items 2 - 5 and 7 - 12
in Table 1 ranged between 1.03 and 1.47 which shows that the responses of the
respondents on those items differ significantly from each other and far from the mean.
Items 1 and 6 had standard deviations of 0.97 and 0.94, which implied that the
respondents responses on the two items do not differ significantly and not far from the
Mean. The implication is that amongst the capital budgeting decision processes which
aid corporate planning for long term survival of manufacturing companies, that
respondents were unanimous in their opinion about analyzing investment proposals in
capital assets and conducting feasibility study on investment proposal.
HO1: There is no significant difference in the mean responses of the management
staff from urban manufacturing companies and those from rural manufacturing
companies on the extent to which capital budgeting processes aid corporate
planning for long term survival of manufacturing companies in Enugu and
Anambra States of Nigeria.
Table 2: A t-test of the Differences between the Means of Urban and Rural
Manufacturing Companies on the Extent Capital Budgeting Decision
Processes Aid Corporate Planning for Long Term Survival of
Manufacturing Companies
S/N
Groups
X
SD
N
DF
Std.
Error
t- Cal
t-Tab
Level
of Sig.
Rmk
1. Urban
Companies
3.11
1.196
304
2. Rural
Companies
3.03
1.195
16 318 0.306
0.319 1.96 0.05 NS
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The t-test analysis presented in Table 2 above revealed that t- calculated (t-
cal) value of 0.319 is less than the t-table (t-tab) value of 1.96 at P≤ 0.05 level of
significance and at 318 degree of freedom (df). This indicated that, there is no
significant difference between the Mean scores of management staff of urban and
rural manufacturing companies on the extent to which capital budgeting decision
processes aid corporate planning for long term survival of manufacturing companies
in the study area. Therefore, the null hypothesis of no significant difference is
accepted.
Research Question 2
What is the extent of management compliance to the use of capital budgeting
techniques for investment analysis?
The items describing the extent of management compliance with the use of
capital budgeting techniques for investment analysis covered items 13 to 19, and the
data is presented in Table 3 below.
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Table 3: Mean Ratings and Standard Deviations of Respondents on the Extent of
Managements’ Compliance to the Use of Capital Budgeting
Techniques for Investment Analysis.
S/N
Item Statements
X
SD
Rmks
13 Net Present Value (NPV) 2.75 0.70 Little Extent
14 Internal Rate of Return (IRR) 2.11 0.83 Little Extent
15 Profitability Index (PI) 2.47 0.83 Little Extent
16 Pay Back Period (PBP) 4.97 0.25 Great Extent
17 Discounted Pay Back Period (DPBP) 2.88 1.03 Little Extent
18 Accounting Rate of Return (ARR) 4.65 0.52 Great Extent
19 Modified Internal Rate of Return
(MIRR)
1.66 0.81 Little Extent
Key: X = Mean
SD = Standard Deviation
Responses to the items in Table 3 above showed that items 16 and 18 had
Mean values of 3.50 and above, indicating that management complied to a great
extent with the use of Pay Back Period and Accounting Rate of Return for investment
analysis. However, items 13 – 15, 17 and 19 have Mean values of less than 3.50
implying that management complied with the use of those items to a little extent, for
investment analysis.
The standard deviation value for item 17 in Table 3 is 1.03 implying that more
of the respondents vary in their opinion on the extent management complied with
Discounted Pay Back Period for investment analysis. Other items in the Table, items
13 – 16, and 18 - 19, had standard deviations of between 0.25 and 0.83 which shows
that the responses of the respondents were not at variance and not far from the mean
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on the extent management complied with the use of NPV, IRR, PI, DPBP, and MIRR
for investment analysis.
HO2: There is no significant difference in the mean responses of the managing
directors, the accountants, and the purchasing managers on management‟s
compliance in the use of capital budgeting techniques in manufacturing
companies.
Table 4: Analysis of Variance (ANOVA) of the Means of Managing Directors,
Accountants and Purchasing Managers on Management’s
Compliance with the use of Capital Budgeting Techniques for
Investment Analysis
Sources of Variance Sum of
Squares
DF Mean
Square
F-Cal F-
Critical
Level
of Sig.
Rmk
Between Groups
0.345
2
0.172
0.401
3.00
0.05
NS
Within Groups 178.053 317 0.562
Total 178.398 319
The analysis of variance (ANOVA) presented in Table 12 above showed that
F- calculated (F-cal) value of 0.401 is less than the F-critical value of 3.00 at P≤ 0.05
level of significance. This indicated that, there is no significant difference in the mean
scores of the responses of Managing Directors, Accountants and Purchasing Mangers
on the management‟s compliance in the use of capital budgeting techniques in
manufacturing companies. Therefore, the null hypothesis of no significant difference
for hypothesis 2 is accepted.
Research Question 3
To what extent does manufacturing companies utilize capital budgeting
investment evaluation criteria for investment decisions?
143
The items dealing with the extent to which manufacturing companies utilize
capital budgeting investment evaluation criteria for investment decisions covered
items 20 to 29, and the data is presented in Table 5 below.
Table 5: Mean Ratings and Standard Deviations of Respondents on the
Extent Manufacturing Companies Utilize Capital Budgeting
Investment Evaluation Criteria for Investment Decisions.
S/N
Item Statements
X
SD
Rmks
20 Discounted Investment evaluation
techniques 1.72 0.93 Rarely Used
21 Non discounted investment evaluation
techniques 4.52 0.80 Much Used
22 Risk adjusted statistical techniques 1.53 0.66 Rarely Used
23 Risk adjusted discount rate 2.64 1.18 Rarely Used
24 Sensitivity analysis 1.70 0.87 Rarely Used
25 Ratio analysis 3.02 1.34 Rarely Used
26 Simulation analysis. 1.49 0.72 Rarely Used
27 Certainty of equivalence 1.09 0.29 Rarely Used
28 Scenario analysis 1.00 0.00 Rarely Used
29 Managements‟ intuitive reasoning and
judgment 3.57 1.36 Much Used
The data presented in table 5 showed that, items 21 and 29 had Mean values of
3.50 and above indicating that manufacturing companies in Enugu and Anambra
States much used non discounted investment evaluation technique and managements‟
intuitive reasoning and judgment for investment decisions. The Mean values of items
20, and 22 – 28, were below 3.50, indicating that those items were rarely used for
investment decisions by manufacturing companies operating in Enugu and Anambra
States of Nigeria.
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Items 23, 25 and 29 in Table 5 had standard deviation values of 1.18, 1.34 and
1.36 implying that more of the respondents vary in their opinion on the extent risk
adjusted discount rate, ratio analysis and managements‟ intuitive reasoning and
judgment was used for investment analysis. Other items in the Table, items 20 – 22,
24, and 26 - 28 had their standard deviations ranged between 0.00 and 0.93; which
shows that, the responses of the respondents were not far from the Mean and from one
another in their opinions on the extent those items were used for investment analysis.
Research Question 4
To what extent do manufacturing companies utilize outsourcing for capital
expenditure decisions?
The items describing the extent to which manufacturing companies utilize
outsourcing for capital expenditure decisions covered items 30 to 41, and the data is
presented in Table 6 below.
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Table 6: Mean Ratings and Standard Deviations of Respondents on the Extent
Manufacturing Companies Utilize Outsourcing for Capital
Expenditure Decisions
S/N
Item Statements
X
SD
Rmks
30 Acquisition of existing business 1.90 0.99 Rarely Used
31 Nursing a business from the scratch 1.45 0.79 Rarely Used
32 Adding capacity to existing product
lines 2.66 1.36 Rarely Used
33 Investment in new product or
products 2.33 1.15 Rarely Used
34 Changing obsolete equipment 1.63 1.00 Rarely Used
35 Replacement of worn-out equipment 1.86 1.11 Rarely Used
36 Sale of a division of the business
(divestment) 3.60 1.26 Much Used
37 Investment in financial assets 3.64 1.11 Much Used
38 Change in the method of sales
distribution 2.33 1.09 Rarely Used
39 Change in advertisement
campaign/strategy 1.96 1.09 Rarely Used
40 Increase in research and development
strategy 2.25 0.87 Rarely Used
41 Deciding on labour mechanism/
device (machine intensive or human
labour)
1.51 0.72 Rarely Used
As can be seen from the data presented in table 6 above, items 36 and 37 had
Mean values of 3.50 and above indicating that majority of the respondents believed
that manufacturing companies much used outsourcing for sale of a division of the
business (divestment), and investment in financial assets. The Mean values of items
30 – 35 and 38 – 41 showed Mean values of below 3.50, implying that outsourcing
was rarely used for those capital expenditure decisions.
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The standard deviation values for items 32 - 39 in Table 6 ranged between
1.00 and 1.36 which shows that the responses of the respondents were far from the
mean and from one another in their responses. However items 30, 31, 40 and 41 had
standard deviations of 0.99, 0.79, 0.87 and 0.72 which implied that more respondents
were close in their opinion on the extent manufacturing companies utilize outsourcing
for those capital expenditure decisions.
HO3: There is no significant difference in the mean responses of the small, medium,
and the large scale manufacturing companies on the extent to which
outsourcing is utilized by manufacturing companies in taking capital
expenditure decisions.
Table 7: Analysis of Variance (ANOVA) of the Means of the Staff of Small,
Medium and Large Scale Manufacturers on the Extent Outsourcing is
Utilized for Capital Expenditure Decisions
Sources of Variance Sum of
Squares
DF Mean
Square
F-Cal F-
Critical
Level of
Sig.
Rmks
Between Groups
81.968
2
40.984
55.987
3.00
0.05
Sig.
Within Groups 276.214 317 0.871
Total 358.182 319
The analysis of variance (ANOVA) presented in Table 7 above showed that F-
calculated (F-cal) value of 55.987 is greater than the F-critical value of 3.00 at P≤
0.05 level of significance. This indicated that, there is significant difference in the
Mean scores of the responses of the staff of Small Scale, Medium Scale and Large
Scale manufacturing companies on the extent to which outsourcing is utilized by
manufacturing companies in taking capital expenditure decisions. The Post-Hoc
analysis (multiple comparison) further revealed that the significant difference exist
147
among the three groups of respondents. Therefore, the null hypothesis of no
significant difference for hypothesis 3 is hereby rejected.
Research Question 5
To what extent does the use of capital budgeting techniques for investment
analysis enhance the earnings of manufacturing companies?
The items dealing with the extent to which the use of capital budgeting
techniques for investment analysis enhance the earnings of manufacturing companies
covered items 42 to 48, and the data is presented in Table 8 below.
Table 8: Mean Ratings and Standard Deviations of Respondents on the Extent
the Use of Capital Budgeting Techniques for Investment Analysis
Enhance the Earnings of Manufacturing Companies
S/N
Item Statements
X
SD
Rmks
42 Net Present Value (NPV) 4.33 1.01 Great Extent
43 Internal Rate of Return (IRR) 3.98 1.25 Great Extent
44 Profitability Index (PI) 3.66 0.83 Great Extent
45 Pay Back Period (PBP) 3.21 1.35 Little Extent
46 Discounted Pay Back Period (DPBP) 3.62 1.03 Great Extent
47 Accounting Rate of Return (ARR) 3.35 1.37 Little Extent
48 Modified Internal Rate of Return (MIRR) 3.23 1.14 Little Extent
For items 42 – 44, and 46, in Table 8 above, the respondents‟ responses
indicated very high mean value of between 3.62 and 4.33. The implication is that the
respondents were in agreement that those capital budgeting techniques when used for
investment analysis enhance the earnings of manufacturing companies to a great
extent. As regards items 45, 47 and 48, with Mean values of less than 3.50, the
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respondents believed that those items enhance manufacturing companies earning to a
little extent.
The standard deviation values for the 6 out of the 7 items, items 42 and 43, and
items 45 – 45, in Table 8, ranged between 1.01 and 1.37, which shows that the
responses of the respondents were far from the mean and from the opinions of one
another. For item 44, with a standard deviation of 0.83, the responses of the
respondents were close to the mean implying that their opinions on the extent
Profitability Index enhance manufacturing companies‟ earnings do not differ
significantly.
HO4: There is no significant difference in the mean responses of the small, medium,
and the large scale manufacturing companies on the extent to which the use of
capital budgeting techniques for investment analysis enhance manufacturing
company‟s earnings.
Table 9: Analysis of Variance (ANOVA) of the Means of Staff of Small,
Medium and Large Scale Manufacturing Companies on the Extent the
Use of Capital Budgeting Techniques for Investment Analysis Enhance
Company’s Earnings
Sources of Variance Sum of
Squares
DF Mean
Square
F-Cal F-
Critical
Level of
Sig.
Rmks
Between Groups
129.281
2
64.640
82.667
3.00
0.05
Sig.
Within Groups 306.908 317 1.968
Total 436.189 319
The analysis of variance (ANOVA) presented in Table 9 above revealed that
F- calculated (F-cal) value of 82.667 is greater than the F-critical value of 3.00 at P≤
0.05 level of significance. This indicated that, there is significant difference in the
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Mean scores of the responses of the staff of Small, Medium and Large Scale
manufacturing companies on the extent to which the use of capital budgeting
techniques for investment analysis enhance manufacturing company‟s earnings. The
Post-Hoc analysis (multiple comparison) further revealed that the significant
difference exist among the three groups of respondents. Therefore, the null hypothesis
of no significant difference for hypothesis 4 is hereby rejected.
Research Question 6
What are the constraints to the effective use of capital budgeting for
investment analysis?
The items dealing with the constraints to the effective use of capital budgeting
for investment analysis covered items 49 to 65, and the data is presented in Table 10
below.
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Table 10: Mean Ratings and Standard Deviations of Respondents on the
Constraints to Effective Use of Capital Budgeting For Investment
Analysis
S/N Item Statements X SD Rmks
49 Inability to Seek and obtain stakeholders support 3.08 1.09 Little Extent
50 Inability to develop meaningful forecasts and plans for
investment analysis 3.50 1.29 Great Extent
51 Lack of knowledge of the budgetary process by the
stakeholders 3.81 0.93 Great Extent
52 Inability to gain the stakeholders full participation in
planning and implementation 3.93 1.17 Great Extent
53 Lack of establishment of realistic objectives 2.13 0.83 Little Extent
54 Inability to establish practical standards for desired
performance 2.52 1.07 Little Extent
55 Management interference with the developed capital
budget 4.78 0.49 Great Extent
56 Inadequate maintenance of effective follow-up
procedure 4.21 0.77 Great Extent
57 Personal biases in management‟s judgment 4.58 0.63 Great Extent
58 The problem of various capital budgeting techniques
yielding different results (selecting a different
proposal)
4.75 0.43 Great Extent
59 Lack of understanding of the sophisticated nature of
capital budgeting tools and techniques for use 3.49 1.14 Great Extent
60 Lack of understanding of the risk measurement
devices 3.11 1.08 Little Extent
61 The problem of analyzing risks and uncertain
investment environment with certainty 3.24 1.25 Little Extent
62 Inflationary problem 3.05 1.21 Little Extent
63 Management‟s over reliance on the capital budgeting
instrument as developed 2.38 1.17 Little Extent
64 Capital budgeting objective being in disharmony with
the company‟s overall objective 2.10 0.74 Little Extent
65 Irregular comparison of standards with actual results
of investment 3.43 1.18 Little Extent
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The data presented in Table 10 above showed that items 50 – 52, and 55 – 59,
constrain capital budgeting to a great extent for investment analysis, as there Mean
values ranged between 3.50 and 4.78. The mean values of between 2.10 and 3.49 for
items 49, 53, 54, and 59 – 65, indicated that those items constrain capital budgeting to
a little extent for investment analysis.
The standard deviation values for items 51, 53, 55 – 58 and 64 in Table 10
ranged between 0.43 and 0.93 which shows that the responses of the respondents
were not far from the mean and from the opinion of one another. The other items in
the Table had standard deviations of between 1.07 and 1.29 which implied that the
responses of the respondents were far from the mean, and that more respondents vary
in their opinion on the extent those items constrain effective use of capital budgeting
for investment analysis.
HO5: There is no significant difference in the mean responses of the management
staff from urban manufacturing companies and those from rural manufacturing
companies on the factors that constrain effective use of capital budgeting for
investment analysis.
Table 11: A t-test of the Differences Between the Means of Urban and Rural
Manufacturing Companies on the Factors that Constrain Effective
use of Capital Budgeting for Investment Analysis
S/N
Groups
X
SD
N
DF
Std.
Error
t- Cal
t-Tab
Level
of Sig.
Rmk
1. Urban
Companies
3.31
0.958
304
2. Rural
Companies
3.66
0.947
16 318 0.247
-0.983
1.96 0.05 NS
The t-test analysis presented in Table 11 above revealed that t-calculated (t-
cal) value of -0.983 is less than the t-table (t-tab) value of 1.96 at P≤ 0.05 level of
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significance and at 318 degree of freedom (df). This indicated that, there is no
significant difference between the mean scores of management staff of urban and
rural manufacturing companies on the factors that constrain effective use of capital
budgeting for investment analysis in the study area. Therefore, the null hypothesis of
no significant difference is accepted.
Research Question 7
What are the strategies for improving on effective use of capital budgeting for
investment analysis?
The items dealing with the strategies for improving on effective use of capital
budgeting for investment analysis covered items 66 to 78, and the data is presented in
Table 12 below.
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Table 12 Mean Ratings and Standard Deviations of Respondents on Strategies
for Improving On Effective Use of Capital Budgeting For Investment
Analysis
S/N Item Statements X SD Rmks
66 Balancing strategic management consideration with
capital budgeting evaluation techniques 4.81 0.46 Great Extent
67 Applying both statistical and conventional risk
adjusted techniques for investment analysis 4.48 0.81 Great Extent
68 Applying more than one capital budgeting techniques
in investment analysis 4.52 0.92 Great Extent
69 Complimenting capital budgeting techniques with risk
adjusted techniques when analyzing capital
expenditure decisions
4.88
0.44
Great Extent
70 Focusing cash flow instead of profit when capital
budgeting techniques are used in investment analysis 4.97 0.21 Great Extent
71 Recognizing time value for money with regards to
investment‟s capital recovery 4.95 0.25 Great Extent
72 Interpreting investment appraisal techniques to
management 3.53 1.13 Great Extent
73 Adhering strictly to the use of capital budgeting policy
manual 4.52 0.76 Great Extent
74 Outsourcing when necessary, capital budgeting
decisions 4.33 0.91 Great Extent
75 Allocating resources to investments under sound
concept of divisional and corporate strategy 4.08 1.01 Great Extent
76 Adopting formidable decision making process 4.59 0.66 Great Extent
77 Allowing financial managers upper hand in taking
capital expenditure decisions 4.94 0.23 Great Extent
78 Decentralizing management functions from core
financial manager‟s functions 4.16 1.02 Great Extent
The data presented in Table 12 above showed that items 66 – 78 had Mean
values of 3.50 and above, indicating that all the items in Table 12, improves effective
use of capital budgeting for investment analysis to great extent.
154
The standard deviation values for items 72, 75 and 78 in Table 12 are 1.13,
1.01 and 1.02, which shows that the responses of the respondents were far from the
mean and from the responses of one another in those items. All other items in the
table, items 66 - 71, 73 - 74, 76 and 77, had standard deviation values of between 0.21
and 0.92 which implied that more respondents were close in their opinion that those
strategies were effective in improving on the use of capital budgeting for investment
analysis.
Major Findings of the Study
Based on the research questions answered and the hypotheses tested, it was
found out that analyzing investment proposal in capital assets, estimation of
investment‟s required rate of returns, conducting feasibility study on investment
proposal, and capital rationing aid corporate planning for long term survival of
manufacturing companies to a great extent. However, the respondents felt that
analyzing departmental operations in line with company‟s overall objectives,
estimation of investment‟s cash flow, comparing expected future streams of cash
flows with immediate and past streams, ranking investment proposals based on
appraisal and evaluation techniques, selecting investment proposal and applying risk
measurement devices, timely selection of capital assets, monitoring of investment on
capital assets, and evaluating capital expenditure decisions for remedial actions aid
corporate planning for long term survival of their manufacturing companies to a little
extent. The tested hypotheses revealed that there is no significant difference in the
Mean ratings of the responses of management staff of urban and rural manufacturing
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companies on the extent capital budgeting decision processes aid corporate planning
for long term survival of manufacturing companies in the study area.
On the extent the management of the manufacturing companies complied with
the use of capital budgeting techniques for investment analysis, the respondents were
in agreement that management complied with the use of Pay Back Period and
Accounting Rate of Returns for investment analysis to a great extent. On the other
hand, the respondents believed that management only complied with the use of Net
Present Value (NPV), Internal Rate of Return (IRR), Profitability Index (PI),
Discounted Pay Back Period (DPBP), and Modified Internal Rate of Return (MIRR)
to a little extent. The Analysis of Variance showed that there is no significant
difference in the mean ratings of the responses of Managing Directors, Accountants
and Purchasing Mangers on management‟s compliance in the use of capital budgeting
techniques in manufacturing companies.
In relation to the extent manufacturing companies utilize capital budgeting
investment evaluation criteria for investment decisions, it was found that non-
discounted investment evaluation technique and managements‟ intuitive reasoning
and judgment were much used for investment decisions. However, it was found that
the discounted investment evaluation techniques, risk adjusted statistical techniques,
risk adjusted discount rate, sensitivity analysis, ratio analysis, simulation analysis,
certainty of equivalence, and scenario analysis were rarely used by the manufacturing
companies for investment decisions.
The findings of the study revealed that manufacturing companies much used
outsourcing for capital expenditure decisions of investing in financial assets and sale
of a division of the business (divestment). On the other hand, it was found that
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outsourcing was rarely used by the manufacturing companies for such capital
expenditure decisions as acquisition of existing business, nursing a business from the
scratch, adding capacity to existing product lines, investment in new product or
products, changing obsolete equipment, replacement of worn-out equipment, change
in the method of sales distribution, change in advertisement campaign/strategy,
increase in research and development strategy, and deciding on labour
mechanism/device (machine intensive or human labour).
The Analysis of Variance (ANOVA) on hypothesis 3 showed that there is
significant difference in the mean scores of the responses of the management staff of
Small, Medium and Large Scale manufacturing companies on the extent to which
outsourcing is utilized by manufacturing companies in taking capital expenditure
decisions. The Post-Hoc analysis (multiple comparison) further revealed that the
significant difference exist among the three groups of respondents.
With regards to the extent the use of capital budgeting techniques for
investment analysis enhance the earnings of manufacturing companies; it was found
that Pay Back Period, Accounting Rate of Return and Modified Internal Rate of
Return when used for investment analysis enhances manufacturing companies‟
earnings to a little extent. However, the respondents felt that the use of Net Present
Value (NPV), Internal Rate of Return (IRR), Profitability Index (PI), and Discounted
Pay Back Period (DPBP), enhances the earnings of their manufacturing companies to
a great extent.
The Analysis of Variance (ANOVA) revealed that there is significant
difference in the Mean ratings of the responses of the management staff of Small,
Medium and Large Scale manufacturing companies on the extent to which the use of
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capital budgeting techniques for investment analysis enhance manufacturing
company‟s earnings. The Post-Hoc analysis (multiple comparison) further revealed
that significant difference exist among the three groups of respondents.
The findings of the study with regards to research question 6 revealed that
inability to develop meaningful forecasts and plans for investment analysis, lack of
knowledge of the budgetary process by the stakeholders, inability to gain the
stakeholders full participation in planning and implementation, management
interference with the developed capital budget, inadequate maintenance of effective
follow-up procedure, personal bias in management‟s judgment, the problem of
various capital budgeting techniques yielding different results (selecting a different
proposal), and lack of understanding of the sophisticated nature of capital budgeting
tools and techniques for use, constrain effective use of capital budgeting for
investment analysis to great extent.
On the other hand, the respondents felt that inability to Seek and obtain
stakeholders support, lack of establishment of realistic objectives, inability to
establish practical standards for desired performance, lack of understanding of the risk
measurement devices, the problem of analyzing risks and uncertain investment
environment with certainty, inflationary problem, management‟s over reliance on the
capital budgeting instrument as developed, capital budgeting objective being in
disharmony with the company‟s overall objective, and irregular comparison of
standards with actual results of investment, constrain effective use of capital
budgeting for investment analysis to a little extent. The result of the t-test statistic
revealed that there is no significant difference between the mean ratings of the
responses of the management staff of urban and rural manufacturing companies on
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the factors that constrain effective use of capital budgeting for investment analysis in
the study area.
The study equally revealed that balancing strategic management consideration
with capital budgeting evaluation techniques, applying both statistical and
conventional risk adjusted techniques for investment analysis, applying more than one
capital budgeting techniques in investment analysis, complimenting capital budgeting
techniques with risk adjusted techniques when analyzing capital expenditure
decisions, focusing cash flow instead of profit when capital budgeting techniques are
used in investment analysis, recognizing time value for money with regards to
investment‟s capital recovery, interpreting investment appraisal techniques to
management, were found to have improved on effective use of capital budgeting for
investment analysis to a great extent. Also, that adhering strictly to the use of capital
budgeting policy manual, outsourcing when necessary, capital budgeting decisions,
allocating resources to investments under sound concept of divisional and corporate
strategy, adopting formidable decision making process, allowing financial managers
upper hand in taking capital expenditure decisions, and decentralizing management
functions from core financial manager‟s functions improved on effective use of
capital budgeting for investment analysis to a great extent.
Discussion of Major Findings
It was found out that the respondents agreed to a great extent that some capital
budgeting decision processes were used to aid corporate planning for long term
survival of their manufacturing companies. Corporate planning of any organization
can be made effective through the application of some capital budgeting decision
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processes. The finding of this study is in agreement with that of Henriksen (2008)
who reported that capital budgeting decision processes such that will give structure
and measurement to your planning and budgeting process, develope strategic
priorities and optimal allocation of resources, give detailed analysis of investment
proposal and a detailed feasibility study, makes corporate planning of any
organisation effective.
The findings of this study with regards to estimation of investment‟s required
rate of returns as a process that aids corporate planning is in conformity with the
submission of Nnamani (2008) who reported that, expected rate of returns (financial
forecast) serve as a yardstick for appraising corporate plan at intervals, thus financial
planning is seen as an integral part of corporate planning. Also in line with the result
of this study is the findings of Jean (2010) who confirmed among others, that an
effective feasibility study serves as a tool in planning, identifies the resource
requirement for the business, gives a detailed analysis of proposal, and suggests
possible recommendations.
In corporate planning, the main benefit of capital rationing is ability to ensure
efficiency in the use of the company's corporate resources. This also corroborate the
findings of Akinsulire (2010) who found out that companies are constrained to accept
all projects with positive NPV‟s, and unless they apply effective capital rationing at
their planning stage, it may be incapacitated in undertaking projects that would have
increased the company‟s market value, hence growth cannot be sufficiently achieved.
In essence, capital rationing helps in corporate planning as it restricts the channels of
outflow by placing a cap on the number of new projects to embark upon to achieve
the company‟s desired financial targets.
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The result of the t-test statistic revealed that, there is no significant difference
between the mean ratings of the responses of management staff of urban and rural
manufacturing companies on the extent to which capital budgeting processes are
utilized for corporate planning for long term survival of the companies. Therefore, the
null hypothesis of no significant difference for hypothesis 1 was accepted. This was in
contrary with the submission of Nnoli (2004) and Adeniji (2004) who reported in
their studies that corporate planning as adopted by companies depends inter alia on
the geographical location of such company. One had expected that location variables
would have had significant influence on the extent to which capital budgeting is
utilized for corporate planning, but the findings of the study revealed otherwise.
The findings pertaining to research question 2 revealed that management
complied to a great extent with the use of Payback Period and Accounting Rate of
Returns for investment analysis. The prime task of capital budgeting is to estimate
capital investment requirements of a business with precision to boost earnings. The
findings of this study is in agreement with the findings of Elumilade, Asaolu and
Ologunde (2006) who investigated capital budgeting and economic development in
the Third World using Nigeria as a case study. They found out among others that the
most common capital budgeting techniques used by both private and public
companies in Nigeria is the payback period and the Accounting Rate of Returns.
Though the authors concluded that capital budgeting decision is a non negotiable
investment decision making strategy that must be taken very seriously, they opined
that the use of investment appraisal techniques that takes into consideration time
value of money is most appropriate. This opinion is not completely in line with the
above findings of this study.
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Howard (2008) in preference to the use of discounted investment evaluation
techniques affirmed that, a more careful selection of investment proposal is attained
when time value for money is considered especially in an inflationary economy.
Nigerian investment environment is so uncertain that not only that a discounted
evaluation technique should be used in investment selection, but a combination of two
to three. In line with this assertion, Adelegan (2010) who conducted a study on
management accounting practices in Nigerian companies found out that majority of
respondents indicated that appraising their capital investments with a combination of
investment appraisal techniques such as internal rate of returns, profitability index,
and net present value techniques are prime in selecting a choicest project. The reason
for the high support of a combination of investment appraisal techniques could be as a
result of the different kinds of investment evaluation techniques yielding different
results (selecting different investment projects), more so with regards to an uncertain
business environment. In the view of Nixon (1995), management‟s failure to comply
with the use of multiple capital budgeting techniques for investment analysis though
its efficacy may be blamed on the complex nature of its application and methods of
computation.
The result of the Analysis of Variance (ANOVA) for hypotheses 2 revealed
that there is no significant difference in the Mean ratings of the responses of
Managing Directors, Accountants and Purchasing Mangers on management‟s
compliance in the use of capital budgeting techniques in manufacturing companies.
The null hypothesis of no significant difference for hypothesis 2 was therefore
accepted. In agreement with the findings of this study is that of Adelegan (2010) who
162
investigated management accounting practices in Nigerian companies and found out
that majority of the companies managements‟ indicated that they appraised their
capital investment decisions with the use of a combination of investment appraisal
techniques such as accounting rate of return and payback period. However, these
opinions differ significantly with regards to the extent managers (managing directors
and purchasing managers) and accountants complied with the use of the discounted
evaluation techniques in evaluating capital expenditure decisions.
As regards how manufacturing companies utilize capital budgeting investment
evaluation criteria for investment decisions, it was found out that, non-discounted
investment evaluation criteria and management intuitive reasoning and judgment
were much used for investment decisions. Hence, Randika, (2010) reported that
sound investment evaluation criteria should be used to measure the economic worth
of an investment project. The findings of this study on utilization of capital budgeting
evaluation criteria by manufacturing companies for investment decisions is in
consonance with that of Harold (2004) who reported that, non-discounted evaluation
technique of capital budgeting such as pay back method is favoured by management
of most companies even when one of the major features of non-discounted evaluation
criteria is that it does not explicitly consider the time value of money.
The findings of this study also corroborate the findings of a study conducted
by Elumilade, et-al (2006) where the authors among others found out that the most
common budgeting techniques used by both private and public companies is the
payback period and the accounting rate of returns which are non discounted capital
budgeting evaluation criteria. The findings of this study contrast the findings of
Enweluzor (2006), who assessed capital budgeting techniques and model and its
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effect on organisations profitability in Anambra State. Enweluzor found out that
company‟s profitability is influenced by the capital budgeting model adopted and that
discounted techniques are preferred to non discounted evaluation criteria. In line with
Enweluzor‟s view, Imegi and Anamakiri (2004) asserted, though non discounted
evaluation criteria may be used for capital budgeting decisions, it must not be used
alone if obtaining faithful result is desired.
As regards the extent to which manufacturing companies utilize outsourcing
for investment decisions, it was found that outsourcing was used to a great extent for
such capital expenditure decisions as investment in financial assets and sales of a
division of the business. Outsourcing is a very successful and increasingly popular
enterprise management strategy. The findings of this study is in conformity with the
submission of Koszewska (2004) who reported the findings of Fortune Magazine that,
over 90% of business organizations today take advantage of external service
providers (outsourcing). And that in the European market alone, the 2001 estimate of
such services was US$27 billion, which is growing from year to year. Koszewska
(2004) reported further that outsourcing was only used by large corporations, but
nowadays it is becoming more and more popular among small-sized enterprises due
to its associated advantages which include; reduced overheads and operational costs,
possibility of converting fixed costs into variable costs, price competitiveness,
improved cost control, possibility of concentrating on firm„s core businesses,
availability of new service options, and reduced capital commitment among others.
This rapid growth in outsourcing has attracted the attention of researchers and
practitioners alike, as they seek to ascertain the value of outsourcing on business
performance. The findings of this study is in conformity with the findings of
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Bertoneche (2005) who assessed the impact of outsourcing on IT companies using a
rigorous statistical approach and found out that there exist a significant and positive
correlation between major outsourcing deals of the IT companies and improvements
in key business metrics for those companies. Bertoneche concluded that outsourcing
is clearly a part of an effective management strategy that companies should adopt to
achieve positive results.
For null hypothesis 3 as revealed by the result of the Analysis of Variance
(ANOVA), it was found out that there is significant difference in the Mean ratings of
the respondents. The null hypothesis of no significant difference was rejected
because the opinions of the management staff of Small, Medium and Large Scale
manufacturing companies on the extent outsourcing is utilized by manufacturing
companies in taking capital expenditure decisions differs significantly. The above
findings agreed with the views of Koszewska (2004) that only large corporations used
outsourcing, probably because of the inherent shortcomings in its use.
This finding also agreed with the submission of Gartner (2004) who reported
that, as many as 80% of outsourcing contracts embarked upon by businesses in
Europe are unproductive, and that European businesses wasted $7 billion on poorly
managed outsourcing deals. This assertion pointed out that despite the enormous
benefits of outsourcing; there are some risk complexities that can mar the use of
outsourcing for investment decisions more so when not carefully handled.
As regards the extent the use of capital budgeting techniques enhance
manufacturing company‟s earnings, it was found that capital budgeting techniques
such as net present value, internal rate of return, profitability index and discounted
165
pay back period when used for investment analysis enhance the earnings of
manufacturing companies to a great extent. The finding of this study is in agreement
with the findings of Enweluzor (2006) who asserted among others that company‟s
profitability is influenced by the capital budgeting model adopted and that discounted
investment evaluation techniques are preferred to non discounted evaluation
techniques. Kazeem (2010) in line with the findings of the present study found out
that the use of discounted capital budgeting techniques help to enhance accountability
for money, allocation of available resources and organization‟s profitability.
Govindarajan and Anthony (2003) opined, discounted investment evaluation
criteria are classic economic models for measuring the profitability of investment
projects. As such, every manager trained in finance must ask for cash flows on a
discounted basis to reach a realistic investment decision. The assertion of this study
is corroborated by the findings of Okoroji (2008), who found out that activity based
budgeting technique increase the viability of companies and also aids the separation
of company‟s activities that add value from that which does not.
The findings as revealed by the result of the Analysis of Variance (ANOVA)
to hypothesis 4 indicated that, there was significant difference in the mean ratings of
the responses of the management staff of small, medium and large scale
manufacturing companies on the extent to which the use of capital budgeting
techniques for investment analysis enhance manufacturing company‟s earnings. The
null hypothesis of no significant difference for hypothesis 4 was therefore rejected.
The rejection of the above hypothesis was because the opinions of managements‟ of
small, medium and large scale companies differ significantly with regards to the
extent to which the non discounted evaluation techniques enhance manufacturing
166
company‟s earning. However, their opinions did not differ with regards to the extent
to which the discounted techniques enhance the company‟s earnings.
It was found that some problems militate against effective use of capital
budgeting for investment analysis in Enugu and Anambra States. These problems
include, inability of the manufacturing companies to develop meaningful forecasts
and plans into the future; inadequate maintenance of effective follow-up procedure;
and lack of understanding of the sophisticated nature of capital budgeting tools and
techniques among others. The findings of this study is in agreement with that of Rao
and Suryanarayana (2010) who evaluated the problems and difficulties in the use
capital budgeting and found out that, future uncertainty, implications of time element
in capturing the cost and benefits of a decision, and management‟s difficulty in
understanding and quantifying the impacts of capital budgeting techniques are some
of the major challenges in the use of capital budgeting for investment analysis.
In line with the findings of this study is the views of Wild, Larson and
Chiappatta (2005) that capital budgeting is constrained by such factors as uncertainty
of outcome, the extent of amount of money involved, the long period of commitment
of such fund, and the sophistication of the evaluation techniques and risk
measurement devices to apply.
The findings of the study was also corroborated by Amalokwu and Ngoasong
(2008) who carried out a study on budgetary and management control process in a
manufacturing using Guinness Nigerian Plc as a case study. The authors found out
that major problems of the company is the budgeting practice of using the previous
year as a base for projecting the current year and uncertainties in market demand,
167
plant, capacity, availability of labour and raw materials, as they all constitute limiting
factors when preparing the company‟s final budgets.
The test of hypothesis 5 revealed that there is no significant difference
between the mean ratings of the responses of management staff of urban and rural
manufacturing companies on the factors that constrain effective use of capital
budgeting for investment analysis. Therefore, the null hypothesis of no significant
difference is accepted. The finding agreed with the findings of Rao and
Suryanarayana (2010) and Akintoye (2008) who investigated the problems and
difficulties in the use of capital budgeting and found out that; future uncertainty,
implications of time element in capturing the costs and benefits of a decision,
management difficulty in understanding and quantification of impacts of capital
budgeting techniques, lack of dynamic structure within an organisation, absence of
connection between compensation and achievements, lack of integration and poorly
trained financial personnel are some of the major challenges in the use of capital
budgeting techniques for investment analysis.
It was found out that the respondents agreed to a great extent that the adoption
of such strategies as, balancing strategic management consideration with capital
evaluation techniques; applying both statistical and conventional risk adjusted
techniques; applying more than one capital budgeting techniques in investment
analysis; complimenting capital budgeting techniques with risk adjusted techniques
when analyzing capital expenditure decision among others, will help the
manufacturing companies improve on effective use of capital budgeting for
investment analysis. This finding agrees with that of Amalokwu and Ngoasong
(2008) that a good management control system that can create and sustain competitive
168
advantage is that built on integrating budgeting and strategic management. The
findings of this study are in compliance with the results of the study conducted by
Elumilade, et- al, (2006) who found out that the processes en-route efficient use of
capital budgeting for investment analysis include: identifying possible investment
projects (originating project ideas more so by line managers), which must be
continuous and repetitive; identifying possible alternatives to the projects being
evaluated; acquiring relevant data on the projects under consideration; and evaluating
the projects from the data assembled (carrying out financial evaluation of the projects
based on the criteria the firm uses). This is with the view that the use of more than
one criterion is preferable. As such combinations of these strategies always apply in
reaching realistic investment decision.
Also in line with the findings of this study, Nolon (2005) itemized possible
procedures for improving on capital budgeting decision to include, combining
statistical and conventional risk adjusted techniques when selecting investment
projects; applying risk adjusted techniques to investment evaluation techniques when
analyzing investment decisions; using cash flow and not profit for DCF computation;
and adhering strictly to the use of the company‟s policy manual. The findings of the
authors cited above had further added some credibility to the findings of this study.
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CHAPTER FIVE
SUMMARY, CONCLUSIONS AND RECOMMENDATIONS
This chapter presents summary of the study, conclusions, and
recommendations.
Restatement of the Problem
As documented in the literature, the roles played by the manufacturing sector
in economic development of most nations are enormous. Unfortunately, the
manufacturing sub-sector in Nigerian economy and Enugu and Anambra states in
particular has continued to decline in growth. This slow pace in growth can be traced
to the „risk averse‟ economic environment which has discouraged diversification and
expansion of local industries. The situation is further complicated by the political,
economic and socio-cultural inconsistencies (Eneh, 2000).
A recent survey conducted by Eneh (2005) showed that 97.6% of Nigeria‟s
industrial and manufacturing sub-sectors are made up of Micro Cottage, Small and
Medium Scale Enterprises (MSMSE‟s), and that three out of four of these firms fail
every year, while nine out of the ten prospective entrepreneurs did not venture into
the business. Similarly, Nzewi (2007) classified the state of the Nigerian
Manufacturing Companies as follows: 30% closed down, 60% ailing, and 10%
operating at sustainable level. Nzewi furthered maintained that one of the major
constraints identified is the business environment – the enabling conditions in terms
of government policies, institutions, physical infrastructure, human resources and
administrative services, were lacking. Nigeria‟s manufacturing sub-sector witnessed
a 12% growth in 1976, and its contribution to Gross Domestic Product rose from 4%
170
in 1973 to 13% in 1983; but turned a negative value of – 0.9% in 1999, from – 2.6%
in 1994 (CBN Statistical Bulletin, 2001).
These rates of failures though may be partly blamed on the socio-political and
economic inconsistencies of Nigeria investment environment, the adequacy, extent of
use, and the efficiency of capital budgeting need to be ascertained. This is necessary
because of the materiality of capital budgeting decisions, which its efficient
application or otherwise, could determine the future prospect of the company. The
problems of predicting events with certainty in an uncertain economic environment,
the complex nature of capital budgeting and method of computation, the
sophistication of the capital budgeting evaluation techniques and risk measurement
devices, and inadequate infrastructure and manpower, affect manufacturing
companies‟ effective operations. These problems also militate against efficient
utilization of capital budgeting in most manufacturing companies. Based on the
foregoing, there was the need to determine the extent to which capital budgeting is
utilized as a tool for optimum investment analysis by manufacturers in Enugu and
Anambra states which necessitated this study.
Summary of the Procedures Used
The major purpose of the study was to determine the extent to which capital
budgeting is being utilized as a tool for optimum investment analysis in
manufacturing companies in Enugu and Anambra states. The study adopted a survey
research design. Seven specific purposes were developed in line with the major
purpose of the study. The study answered seven research questions and tested five
null hypotheses at 0.05 level of significance. The population of the study consisted of
171
552 management staff of the 138 registered manufacturing companies operating in
Enugu and Anambra states. Stratified random sampling technique was used to select
a total of 336 management staff of 84 manufacturing companies which therefore
constituted the sample. The questionnaire was structured on a 5-point rating scale and
was validated by five experts; two from the Department of Vocational Teacher
Education, University of Nigeria, Nsukka; two from Accountancy Department of
University of Nigeria, Enugu Campus, and one professional Accountant from Bursary
Department of the University of Nigeria, Nsukka. Their suggestions were
incorporated to improve the final draft of the instrument used for the study. Cronbach
Alpha reliability coefficient of 0.95 was obtained for the entire items in the
instrument, while the 7 clusters had Cronbach Alpha coefficients of 0.959, 0.953,
0.967, 0.932, 0.972, 0.940 and 0.984. A total of 320 copies of the 336 questionnaire
administered were retrieved, representing about 95% retrieval. The data collected
were analyzed using frequency and mean score for answering the seven research
questions. T-test statistic and analysis of variance (ANOVA) were used in testing the
five null hypotheses at 0.05 level of significance and 318 degree of freedom (df) for
the t-test statistic.
Summary of Findings
Based on the data analyzed, the following findings were made:
1. Capital budgeting decision processes was used to a little extent to aid
corporate planning for long term survival of the manufacturing companies in
Enugu and Anambra states.
172
2. Management of manufacturing companies complied with the use of capital
budgeting techniques for investment analysis .
3. Manufacturing companies rarely use capital budgeting investment evaluation
criteria for investment decisions.
4. Manufacturing companies rarely use outsourcing for capital expenditure
decisions.
5. Manufacturing companies use capital budgeting techniques to a little extent for
investment analysis in order to enhance their earnings.
6. Manufacturing companies to a great extent face some constraints which
impede effective use of capital budgeting techniques for investment analysis.
7. Balancing strategic management consideration with capital budgeting
evaluation techniques among other strategies could improve on effective use
of capital budgeting for investment analysis to a great extent.
8. There is no significant difference between the mean ratings of the responses of
management staff of urban and rural manufacturing companies on the extent to
which the use of capital budgeting decision processes aid corporate planning
for long term survival of the companies.
9. There is no significant difference among the mean ratings of the responses of
Managing Directors, Accountants and Purchasing Mangers on the
management‟s compliance in the use of capital budgeting techniques in
manufacturing companies.
10. There is significant difference among the mean ratings of the responses of the
management staff of Small, Medium and Large Scale manufacturing
173
companies on the extent to which outsourcing is utilized by manufacturing
companies in taking capital expenditure decisions.
11. There is significant difference among the mean ratings of the responses of the
management staff of small, medium and large scale manufacturing companies
on the extent to which the use of capital budgeting techniques for investment
analysis enhance manufacturing company‟s earnings.
12. There is no significant difference between the mean ratings of the responses of
management staff of urban and rural manufacturing companies on the factors
that constrain effective use of capital budgeting for investment analysis.
Conclusions
The following conclusions were drawn based on the findings of this study.
1. The managing directors, accountants, internal auditors and purchasing
managers unanimously agreed that analyzing investment proposals in capital
assets, estimation of investment required rates of returns, conducting
feasibility study and capital rationing aid corporate planning to a great extent
for the long term survival of manufacturing companies.
2. The managing directors, accountants, internal auditors and purchasing
managers are in agreement that management complied to a great extent with
the use of pay back period and accounting rate of returns for investment
analysis.
3. The managing directors, accountants, internal auditors and purchasing
managers unanimously agreed that manufacturing companies much used non
174
discounted investment evaluation techniques and management‟s intuitive
reasoning and judgment for investment decisions.
4. The managing directors, accountants, internal auditors and purchasing
managers unanimously agreed that outsourcing is rarely used by their
manufacturing companies for capital expenditure decisions.
5. The managing directors, accountants, internal auditors and purchasing
managers are in agreement that the use of net present value and internal rate of
returns for investment analysis enhance the earnings of manufacturing
companies to a great extent.
6. The managing directors, accountants, internal auditors and purchasing
managers are in agreement that the constraints to effective use of capital
budgeting for investment analysis included among others: i) management‟s
interference with the developed capital budget; ii) personal biases in
management‟s judgment; iii) the problem of various capital budgeting
techniques yielding different results; and iv) lack of understanding of the
sophisticated nature of capital budgeting tools and techniques.
7. The managing directors, accountants, internal auditors and purchasing
managers agreed that the following strategies, among others, would improve
on effective use of capital budgeting for investment analysis: i) balancing
strategic management considerations with capital budgeting evaluation
techniques; ii) complimenting capital budgeting techniques with risk adjusted
techniques when analyzing capital expenditure decisions; iii) focusing on cash
flow instead of profit when capital budgeting techniques are used in
175
investment analysis; and iv) recognizing time value for money with regards to
investment‟s capital recovery.
Implications for Accounting Education
The findings of this study have the following positive implications for
accounting education.
1. The knowledge gained from the findings of this study especially on the
decision processes enroute corporate planning would likely aid students of
accounting prosper in business and become self reliant after school. More so
as Business Education aims at achieving self sustenance and independence.
2. The knowledge of the extent to which capital budgeting is utilized by
manufacturing companies for investment analysis would assist accounting
educators to improve on their course content, method of teaching, consistent
curriculum planning and review for the production of quality graduates with
saleable skills in financial management.
3. Accounting educators with the knowledge gained from the findings of this
study would be able to educate students and advise management of
manufacturing companies that effective use of capital budgeting techniques
strengthens corporate plan through timely and optimum employment of capital
for maximum returns. Also that outsourcing could be used to invest idle
fund/savings to yield maximum returns.
4. The findings of this study have produced a wealth of knowledge that could
enable accounting educators guide policy makers and public authorities in
formulating appropriate investment policies, and also in recommending
176
regulatory measures that are geared towards promoting the manufacturing sub-
sector of the economy in order to foster economic and national development.
Recommendations
Based on the major findings of this study, the following recommendations
were made:
1. Management of manufacturing companies should ensure the use of discounted
capital budgeting techniques, and allow financial managers free hand in
investment/project evaluation and selection.
2. Outsourcing as an effective management strategy should be widely adopted by
the manufacturing sector, though with utmost care, to reap such business
benefits as, reduced overheads and operational costs; possibility of converting
fixed costs into variable costs; improved cost control; and the possibility of
concentrating on firm„s core business among others.
3. Identified problems militating against the manufacturing companies‟ effective
use of capital budgeting techniques should be properly addressed by the
management through the provision of adequate measures.
4. Identified strategies for improving on effective use of capital budgeting for
investment analysis should be adopted by manufacturing companies in order to
achieve the desired results of maximum returns on investment.
5. Manufacturing Association of Nigeria (MAN), among other roles they play,
should aid its members to access cheap fund, as well as play supervisory role
on their investments.
177
Suggestion for Further Research
The following related areas have been suggested for further research:
1. The present study should be replicated in other business establishments and
manufacturing companies in other States of the country.
2. Research should be conducted on strategies for implementing effective use
capital budgeting techniques among manufacturing companies for investment
analysis.
3. An analysis of the capital budgeting systems and practices in the public sector
of a given state in the country should be conducted.
4. A comparative study of the budgetary control systems of private and public
sector of Nigerian economy should equally be conducted.
178
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APPENDIX A
LETTER OF INTRODUCTION
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………………………………………..
………………………………………..
………………………………………..
Research Work
The bearer Agboh, Callistus IK, PG/Ph.D/06/42140 is an postgraduate student
of the Department of Vocational Teacher Education of the University of Nigeria,
Nsukka. He is currently undertaking work on: Utilization of Capital Budgeting as an
Optimal Tool For Investment Analysis in Manufacturing Companies in Enugu and
Anambra States.
It would be highly appreciated if you could supply him with the information
he may require from you. All information from you will be treated confidentially.
Thank you for your co-operation.
Dr. E. E. AGOMUO Head Dept. of Voc. Tr. Education
189
APPENDIX B
EVIDIENCE OF INSTRUMENT VALIDATION
190
APPENDIX C
QUESTIONNAIRE
Department of Vocational Teacher Education,
Business Education Unit,
University of Nigeria,
Nsukka.
2nd December, 2009.
Dear Respondent,
I am a postgraduate student in the above Department currently conducting a
research on Utilization of Capital Budgeting as a Tool for Optimum Investment
Analysis in Manufacturing Companies in Eungu State.
You have been selected as one who would furnish the researcher with the
relevant information to aid the effective conduct of this research. The researcher will
be pleased if you sincerely complete the attached questionnaire.
You are assured that the information supplied will be treated with strict
confidentiality and used only for the purpose of this study.
Thanks.
Yours faithfully,
Agboh, C. Ik
CAPITAL BUDGETING APPRAISAL QUESTIONNAIRE (CBAQ) FOR
MANUFACTURING COMPANIES IN ENUGU STATE
Section A: General Information
Instruction: Tick the option or options, which apply to you and your company; and
fill in the space where necessary.
1. Name of your company ………………………………………………….
2. The town in which your company is located is ………………….………
191
3. The capital employed of my company is:
i. N1.5 million and below [ ]
ii. between N1.6 and N50 million [ ]
iii. between N51 and N200 million [ ]
iv. above N200 million [ ]
4. Your job position in the company is
a. Managing Director [ ]
b. Accountant [ ]
c. Internal Auditor [ ]
d. Purchasing Manager [ ]
Section B: The Extent Capital Budgeting Processes are Used to Aid
Corporate Planning for Long Term Survival of Manufacturing
Companies
Response categories for Sections B-H
Very Much Used/Very Great Extent (VMU/VGE) 5
Much Used/Great Extent (MU/GE) 4
Used on Average/Little Extent (UOA/LE) 3
Rarely used/Very Little Extent (RU/VLE) 2
Not Used/No Extent (NU/NE) 1
Instruction: Indicate the extent to which each of the following capital budgeting
processes aid corporate planning for long term survival of your
manufacturing company
Item
No
Item Statements VGE GE LE VLE NE
1 Analysing investment proposals in
capital assets
2 Analysing departmental operations in
line with company‟s overall objectives
3 Estimation of investment‟s cash flow
4 Estimation of investment‟s required rate
192
of returns
5 Comparing expected future streams of
cash flows with immediate and past
streams
6 Conducting feasibility study on
investment proposal
7 Ranking investment proposals based on
appraisal and evaluation techniques
8 Capital rationing
9 Selecting investment proposal and
applying risk measurement devices
10 Timely selection of capital assets
11 Monitoring of investment on capital
assets
12 Evaluating capital expenditure
decisions for remedial actions
Section C: The Extent of your Manufacturing Company’s Compliance with
the use of capital budgeting techniques for Investment Analysis.
Instruction: Indicate the extent to which each of the following investment
evaluation technique is used by your company for investment analysis.
Item
No
Investment Evaluation Techniques VGE GE LE VLE NE
1 Net Present Value (NPV)
2 Internal Rate of Return (IRR)
3 Profitability Index (PI)
4 Pay Back Period (PBP)
5 Discounted Pay Back Period (DPBP)
6 Accounting Rate of Return (ARR)
7 Modified Internal Rate of Return
(MIRR)
Section D: The Extent of Utilization of Capital Budgeting Investment
Evaluation Criteria for Investment Decisions.
193
Instruction: Indicate the extent to which each of the following capital budgeting
investment evaluation criteria are used by your company for investment
decisions.
Item
No
Item Statements VMU MU UOA RU NU
1 Discounted Investment evaluation
techniques.
2 Non discounted investment evaluation
techniques
3 Risk adjusted statistical techniques
4 Risk adjusted discount rate
5 Sensitivity analysis
6 Ratio analysis
7 Simulation analysis
8 Certainty of equivalence
9 Scenario analysis
10 Managements‟ intuitive reasoning and
judgment
Section E: The Extent to which Outsourcing is utilized in taking Capital
Expenditure decisions in your Manufacturing Company
Instruction: Indicate the extent to which outsourcing is utilized in taking the
following capital expenditure decisions in your manufacturing
company.
Item
No
Item Statements VMU MU UOA RU NU
1 Acquisition of existing business
2 Nursing a business from the scratch
3 Adding capacity to existing product
lines
4 Investment in new product or
products
5 Changing obsolete equipment
6 Replacement of worn-out equipment
7 Sale of a division of the business
(divestment)
8 Investment in financial assets
9 Change in the method of sales
194
distribution
10 Change in advertisement
campaign/strategy
11 Increase in research and
development strategy
12 Deciding on labour
mechanism/device (machine
intensive or human labour)
Section F: Effect of the Use of Capital Budgeting Techniques for Investment
Analysis on Manufacturing Companies earning
Instruction: Indicate the extent to which the use of the following capital budgeting
techniques for investment analysis enhance your manufacturing
company‟s earnings
Item
No
Item Statements VGE GE LE VLE NE
1 Net Present Value (NPV)
2 Internal Rate of Return (IRR)
3 Profitability Index (PI)
4 Pay Back Period (PBP)
5 Discounted Pay Back Period (DPBP)
6 Accounting Rate of Return (ARR)
7 Modified Internal Rate of Return (MIRR)
Section G: Constraints to Effective use of Capital Budgeting for Investment
Analysis
Instruction:. Indicate the extent to which each of the following statements constrain
effective use of capital budgeting for investment analysis
Item
No
Item Statements VGE GE LE VLE NE
1 Inability to Seek and obtain stakeholders
support
2 Inability to develop meaningful forecasts
and plans for investment analysis
3 Lack of knowledge of the budgetary
process by the stakeholders
4 Inability to gain the stakeholders full
participation in planning and
195
implementation
5 Lack of establishment of realistic
objectives
6 Inability to establish practical standards
for desired performance
7 Management interference with the
developed capital budget
8 Inadequate maintenance of effective
follow-up procedure
9 Personal biases in management‟s
judgment
10 The problem of various capital budgeting
techniques yielding different results
(selecting a different proposal)
11 Lack of understanding of the
sophisticated nature of capital budgeting
tools and techniques for use
12 Lack of understanding of the risk
measurement devices
13 The problem of analyzing risks and
uncertain investment environment with
certainty
14 Inflation and problem
15 Management‟s over reliance on the
capital budgeting instrument as developed
16 Capital budgeting objective being in
disharmony with the company‟s overall
objective
17 Irregular comparison of standards with
actual results of investment
Section H: Strategies for Improving Effective Utilization of Capital Budgeting
for Investment Analysis
Instruction: Indicate the extent to which the adoption of the following strategies
improve effective utilization of capital budgeting for investment analysis
Item
No
Item Statements VGE GE LE VLE NE
1. Balancing strategic management
consideration with capital budgeting
evaluation techniques
196
2. Applying both statistical and
conventional risk adjusted techniques for
investment analysis
3. Applying more than one capital
budgeting techniques in investment
analysis
4. Complimenting capital budgeting
techniques with risk adjusted techniques
when analyzing capital expenditure
decisions
5. Focusing cashflow instead of profit when
capital budgeting techniques are used in
investment analysis
6. Recognizing time value for money with
regards to investment‟s capital recovery
7. Interpreting investment appraisal
techniques to management
8. Adhering strictly to the use of capital
budgeting policy manual
9. Outsourcing when necessary, capital
budgeting decisions
10. Allocating resources to investments under
sound concept of divisional and corporate
strategy
11. Adopting formidable decision making
process
12. Allowing financial managers upper hand
in taking capital expenditure decisions
13. Decentralizing management functions
from core financial manager‟s functions
197
APPENDIX D
LIST OF URBAN AND RURAL; SMALL, MEDIUM AND LARGE SCALE
MANUFACTURING COMPANIES IN ENUGU AND ANAMBRA STATES
ENUGU STATE – Small, Medium, and Large Scale Manufacturing Companies
Enugu East Senatorial Zone – Urban Manufacturing Companies
A. Small Scale
1. Vac Industries (Nig) Ltd. – 17A Emene Industrial Layout. Enugu.
2. Zaken Industries Co. Ltd. – 20 Nsude Aniagu Street Awkunanaw Enugu.
3. A.C. Drungs Ltd. – 4 Alor Road, Edward Nnaji Layout, Abakpa, Enugu.
4. Ceenek Pharam. Industrial Ltd. - Plot 219 Ibagwa-Aka Street. Nike Comm.
Layout Ext. Phase 2 - Box 1252, Enugu.
5. Emy Holdings Nig Ltd. – No 1 Avenue, Independence Layout P. O. Box 563,
Enugu.
6. Michelie Laboratories Ltd. – Plot 23, Block 2, Thinkers Corner, Emene.
7. Vadis Ltd – 8 Chukuwemka Ikpeze Close. Offhill view Street Trans
Ekulu,Box 30, Enugu.
B. Medium Scale
8. Bons West Africa Ltd. - K/m 2 Enugu/Onitisha Road, Trans-Ekulu, Box 21,
Enugu
9. San-Savana Oil Co. - Ltd. K/m1/2 Abakaliki Exp. Way Akponga Nike,
Village, Box 376 Emene Enugu.
10. Cinnamon Drugs Ltd. – RC 611227, Plot C9, Emene Industrial Layout.
11. Dezem Nig. Ltd. - 87 Ogui Road, Box 9233, Enugu.
12. Hardis and Dromedas Ltd. – Hardis Industrial Estate, Airport Road, Emene.
13. Integrated Chemicals Ltd. – No 3 Isuochi Street, Uwani, Enugu.
14. Juhel Nig Ltd, 418u-Oba Close, Trans Ekulu, P.O. Box 1549, Enugu.
198
15. Nalin Paints and Chemical Co. (Nig) Ltd. - 241 Thinkers Corner, Enugu.
16. Sharon Paints and Chemical Co. (Nig) Ltd. - 241 Agbani Road, Box 136
Enugu
17. Piko Plastics Industries 213Agbani Road, Box 3666, Enugu
18. Robertson Nig Ltd. - Emene Industrial Layout, Emene – Enugu.
19. Fraser Diving Inter. Ltd. – Block B2 Hardis Industrial Estate, Airport Road,
Emene – Enugu.
20. Dunon Furniture Industries Ltd. – 11/15 Manugo Street, Box 745, Emene.
21. Omatha Automobile Products Ltd. – 33 Omatha Holdings Factory, Emene,
P.M.B. 2525 Enugu.
C. Large Scale Manufacturing Companies
22. Homus Steel Ltd. – Plot 3/2 1n/5 Harbour Ind. Layout, Emene.
23. Alo Aluminum Manufacturing Company Ltd. – Enugu-Abakaliki Express
Way, Opp. Mobil Filling Station, Enugu.
24. Emenite Ltd. – Thinkers Corner, Emene-Enugu, Box 646.
25. Anambra Motor Manufacturing Ltd. – Emene Industial Layout, Enugu.
Rural
26. General Metals Nig. Ltd. Enugu – PH Express Road, Ndiagu Amechi
Awkunanaw.
Enugu West Senatorial Zone – Rural Manufacturing Companies
A. Small Scale
1. Ehae Adirindo Nigeria Ltd. – Klm 2 Enugu/Onitisha Expressway, 9th Mile
Corner, Ngwo.
B. Medium Scale – Nil
C. Large Scale
2. Nigerian Breweries Plc. – 9th Mile Corner, Ngwo, Enugu State.
199
Enugu North Senatorial Zone – Urban Manufacturing Company
A. Small Scale – Nil
B. Medium Scale – Nil
C. Large Scale
1. Cospam Nigeria Ltd. – 126 Enugu Road, Nsukka.
ANAMBRA STATE - Small, Medium and Large Scale Manufacturing
Companies
Anambra Central Senatorial Zone – Urban Manufacturing Companies
A. Small Scale
1. Rexton Industries Ltd. – 2 Ugwunabankpa Road, Box 7753, Onitisha.
2. Zubee International Co. Ltd. – 44 Ozomogana Street, Box 2258 Onitisha.
3. Chazmax Pharm. Industrial Ltd. – Klm 2 Nkpo-Obosi Rd., Box 295, Onitisha.
4. Kates Associated Industries Ltd., Plot 1/76 Industries Layout, Bridge Head,
Onitisha.
5. Martha Industries Nigeria Ltd. – Enugu/Ozalla Road, Onitisha.
6. Envoy Oil Industries Ltd. – Box 13465, Onitisha.
7. Nando Pharmacy Limited – 51 Old Market Road, Onitisha.
8. Elephant Chemicals Inds. Ltd. – P. O. Box 410, Onitisha.
9. F. A. Ike and Sons Ltd. – Plot In/29B, Habour Inds. Layout, Onitsha.
10. Basmic Plastic Inds. Nig. Ltd. – Awada Industrial Layout, Onitsha.
11. Daco Foam and Chem. Ind. Ltd. – 15 Obeledu Street, Onitsha.
12. Matag Ltd. – 29 Niger Steet, Fegge, Onitsha.
13. Peter E. Venture Nig. Ltd. – 9/11 Isiokpo Street, Onitsha.
14. Emic Foam and Allied Inds. Ltd. – P.O. Box 570, Onitisha.
200
B. Medium Scale
15. Golden Oil Industries Ltd. 51A Pokobros Industrial Avenue, Habour Industrial
estate Onitisha.
16. Pokobros Food and Chemicals Industrial Ltd. – Box 10001, Fegge Onitisha.
17. Shrifats and Magarine Ltd. – Plot 26, Block 2A ACME Road, Ogba GPO,
Lagos; and Plots 51/52 Habour Industrial L/out, off Attain Rd. Onitisha.
18. AESF AP Ltd. - 97 Onitisha-Owerri Road, Onitisha.
19. C. C. Umeji Agro Allied Co. Ltd. – 15 Arch Bishop Henry Street, Odoakpu,
Box 2591 Onitisha.
20. E. Amobi Manufacturing Company Ltd. – 9 Archbishop street, Onitisha
21. Group Enterprises (Nig) Ltd Plot 19/83 Niger Bridge Industries layout,
Onitisha.28/29.
22. Pegofor Industrial Ltd. – 43/53 Iweke Road, Onitisha.
23. Eastern Desterlleries Food Industries Ltd. – Klm 2 Atani Road, Onitisha.
24. Rico Pharm. Inds. (Nig.) Ltd. – 26 Nafia Street, l Omagba Phase II, Onitsha.
25. Speciality Oil Company Nig. Limited – Plot In/10 12X14 Niger Bridge Head
Ind. L/Out, Onitsha.
26. Tracopet Inds. Ltd. – 9/10 Upper Iweka Road, Opp. Old Ochanja Market,
Onitsha.
27. Dozzy Group Ltd – Plot In/14 Niger Bridge Head, Onitsha.
28. Ezenwa Plastics Ind. Ltd. – Ichi Street Ind. L/out, Onitsha.
29. Gabee Inds. Ltd. – 58B Old Market Road, Onitsha.
30. Gabinson Inds. Ltd. – 12 Douglas Street, Onitisha.
31. Group Enterprises (Nig) Ltd – Plot 19/83 Niger Inds Layout, Onitsha.
32. MAN Plastics Industries – 48 Ezeiweka Road, Awada, Onitsha.
33. M/S Peters and Daniels Ind. Nig. Ltd. – 113 PH Road, Onitsha.
34. Sa-Nwinco Inds. Ltd. – 9 Danco Estate, Onitsha.
201
35. Bonanza Industries Company Nig. Ltd. – Plot In/162 Industrial Layout
Onitisha.
36. Brollo Pipes and Profiles Industries Ltd. – plot In/162 industrial Onitisha.
37. IUNT Industries Ltd. – 97B Onitisha Owerri Road, Onitisha.
38. Robertson Nigeria Limited. Box 788, Onitisha
39. Chriscord Industry Ltd. – Nkpor-Umuoji Road, Onitisha.
40. B. C. Ifegbo and Associates Ltd. – 25 New market Road, Onitisha.
41. L. L. Nwadike and Associates Ltd. – 12 New Market Road, Onitisha.
42. Caprisage Exp. Wood and Furniture Co. Ltd. – Bridge Head, Behind Tomato
Market, Onitisha.
43. Franklin Marble Industries Ltd. – 31Awka Road, Onitisha.
44. Sylver Concrete Industries Ltd. – k/m 3 Nkpor-Obosi Road, Fegge, Onitisha.
45. Bonanza Industry Company Ltd – Fegge, Onitisha.
46. Fezel Nigeria Ltd. - k/m 30, Okigwe/ Onitisha Express Way, Uga.
47. Iju Inds. Ltd, 39 Awka Road, Onitisha.
48. Basico Bicycle Manufacturing Co. Ltd. – 10b Osamele Street, Odakpu,
Onitisha.
49. Godwin Okafor and Sons Ltd. – Box 1419, Onitisha.
Rural Manufacturing Company
50. Tracopet Industries Ltd. –- 8 Ofoma Street, Nkpukpa, Ogburu LGA, Anambra
State.
C. Large Scale Manufacturing Companies
51. Best Aluminum (Mfg) CO. Ltd. – 30D PH Road, Onitisha.
52. Delta Floor Mills Nigeria Limited – Klm 18 Onitisha/Enugu Express Way,
Onitisha.
53. Nigerian Mineral Waters Industries Ltd. – P. M. B. 1549, Onitisha.
202
54. GINPAT Aluminum products Ltd. – k/m 12, Onitisha – Enugu Express Way,
Onitisha.
55. Onitisha Aluminum Manufacturing Co. Ltd. – 10 Akunnia Njote Street,
Woliwo, Onitisha.
56. Africana – First Publishers Ltd. – Niger Bridge Head, Onitisha.
57. Denson Paper Mill Ltd. – 24 New Market Road, Onitisha.
58. Niger Paper industry Nigeria Ltd. – Niger Bridge Head, Onitisha.
59. Geolis Cables Ltd. – Nkpor-Umuoji Road, Onitisha.
60. Dozzy Oil and Gas Ltd – Plot IN/10 and 12 Niger Bridge Head Industrial
Layout, Onitisha.
61. Delta Floor Mills Nig. Ltd. – K/m 18 Onitisha/Enugu Express Way, Onitisha.
62. Niger Automobile Industry Ltd. – Box 4327, Onitisha.
Anambra South Senatorial Zone – Urban Manufacturing Companies
A. Small Scale Manufacturing Companies
1. Ogenna Rice Mills Ltd. – 4 Pokobros Industrial Avenue, Box 322, Nnewi.
2. Eziobi Motors Nig. Ltd. – Zone 12 Block A34 Store No. 2 main market, Box
2834, Nnewi
3. Steveana Ltd. – 60 Igwe Orizu Road, Nnewi.
4. Todson Enterprises – 4 Edo Ezemewi Road, Box 99, Nnewi.
5. Variations Industries Ltd. – 37 Igwe Orizu Road, Box 131, Nnewi.
6. P.M.S. Electrical Mfg. (Nig). Ltd. – 1 PMS Road, Otolo Nnewi.
B. Medium Scale Manufacturing Companies
7. Resources Improvement and Manufacturing Co. Ltd. – Akwa-Uru Industrial
Estate, P. O. Box 905, Nnewi.
8. A-Z Petrochemicals Ind. Ltd. – Akwu-Uru Inds. Estate, Umudium, P.M.B.
5088, Nnewi.
203
9. Jimex Inds. Nig. Ltd. – Umuamaka Village, I industrial Avenue, P.M.B. 5005,
Nnewi.
10. Alf Williams Inds. 14 New Market Road, Box 567, Nnewi.
11. Osychris Inds. (Nig.) Ltd. – 5 New Motorcycle Spare Parts Road, Nnewi.
12. Uru Inds. Ltd. – Akwu-Uru Ind. Estate, P.O. Box 6, Nnewi.
Rural
13. Emos Best Ind. Ltd – 82 Upper New Market Road, P.O. 173, Nkwelle
Ezumaka.
14. Jagua Pan-African Ind.Ltd – Oharegbu Road, Box 192, Okija.
C. Large Scale Manufacturing Companies (Urban)
15. OCE Filters Manufacturing Inds. Ltd. - Mile 12 New Onitisha Road,
Akabaukwu Uruagu, Box 322, Nnewi.
16. Union Auto Parts Mfg. Co. Ltd. – 60/61 Igwe Orizu Road, Box 131, Nnewi.
17. Louis Cater Inds. Ltd. – 9 Emma Okafor Street Akabaukwu, P.O. Box 2757,
Nnewi.
18. Innoson Nigeria Ltd. – 20 New Market Road, Box 1065, Nnewi.
19. Nigerian Starch Mills Ltd. – Ihiala.
20. Adswich Plc. - 1 Metu Uzodike Street, Okpuno Otolo, Nnewi.
21. Cuitix Plc. - 1 Metu Uzodile Street, P. M. B. 5040, Nnewi.
Anambra North Senatorial Zone – Urban Manufacturing Companies
A. Small Scale Manufacturing Companies
1. Mikson Industries Ltd. – Block 1 Unity Lane, New Tyre‟s Market, Nkpor.
2. Gauze Pharam. and Labs. Ltd. - New Govt. House, Enugu –Ifite, Awka.
3. Kingsize Pharam. Nig. Ltd. – Off klm 15 Old Enugu Road, Uruoji Village,
Ogidi.
204
4. Marta Foam Industries Ltd. – 28/29 Enugu-Ozalla Road, Odume-Obosi.
5. Maryment Nig. Ltd. – 34 New Market Road, Nkpor.
6. Fenok Industries Ltd. – Klm 6 Onitisha/Owerri Road, Obosi.
B. Medium Scale Industries
7. Niccus Metals and Iron Industries Ltd. – 43 Obosi Road, Nkpor junction,
Obosi, Anambra State.
8. Gafa Industries Nig. Ltd. – Plot 50, Odume Layout, Obosi, Box 10305,
Onitisha.
9. Pharmacy Gas Ltd, Plot 278 Awka Industries Estate, Awka.
10. Awutolo Industries Ltd. - Agu Awka Industrial Layout, Awka.
11. Climax Industry Ltd. – 48 Nanka Street, Odume layout, Obosi.
12. Curtis – Jas Industry Ltd; 43 Obetedit Street. Off Enugu/Onitisha
Express, Nkpor.
13. Elephant Chemical Industry Ltd. – 33 Nwaka Street, Odume Layout, Obosi,
Box 410, Onitisha.
14. Emic Foam and Allied Industries Ltd. – 1, 3 & 5 Emic Road Odume Layout,
Obosi.
15. GASFA Industries Ltd. – 50 Nduka Street, Oduma, Obosi.
16. Godwin Okafor & Sons Ltd. – Plot 231 Pokobros Avenue Industrial Layout,
Awka.
17. Chriscord Industries Limited. Nkpor - Umuoji Road, Obosi.
18. Mecury Foam Industries Ltd. 15/20 Okija Street, Ozalla Layout, Box 865,
Awka.
19. Ozalla Plastics Entr. Ltd. – Plot 253 Awka Inds. Layout, Box 865, Awka.
20. Niger Chemicals Inds. (W/A) Ltd. – Klm 29 Onitisha Ogbaru Road,
Umunankwo, Obosi.
205
21. Niccus Paper and Printing Industries Ltd. – 44 Obosi Road, Nkpor Junction,
Obosi.
22. Saga Foam and Chemicals Industry Ltd; Offor Lane Obeledu Street Nkpor.
C. Large Scale Manufacturing Companies
23. Finoplastic Industries Ltd. – Plot 182 Ikenga Industries Layout, Box 14,
Nawfia.
24. Global Concepts (W/A) Industry Ltd. – Plot EL 7/8 Ikenga, GPO, Box 1264,
Awka.
25. Whiz Products (WA) Ltd. – Plot 217B Awka Industrial Layout, Box 583,
Awka.
26. Life Breweries Co. Ltd. – Box 657, Awka.
206
APPENDIX E
Table 1: Population Distribution
State/Senatorial
Zone
Nature of Location/No of
Manufacturing Companies
Population of
Management Staff
Enugu Rural Urban Total
East 1 25 26 104
West 2 - 2 8
North - 1 1 4
Sub Total 3 26 29 116
Anambra
Central 1 61 62 248
North - 26 26 104
South 2 19 21 84
Sub Total 3 106 109 436
Grand Total 6 132 138 552
Table 2: Sample Distribution
State/Senatorial
Zone
Nature of
Location/Population
of Manufacturing
Companies
Nature of
Location/Sample
Size of
Manufacturing
Companies
Sample Size of
Management
Staff
Rural Urban Rural Urban
Enugu
East 1 25 1 15 64
West 2 - 1 - 4
North - 1 - 1 4
Anambra
Central 1 61 1 37 152
North - 26 - 16 64
South 2 19 1 11 48
Total 6 132 4 80 336
Source: MAN Zonal Office, Enugu; State Town Planning Headquarters, Enugu;
and State Ministry of Lands, Survey and Urban Planning, Awka (2007).