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AGBOH, CALLISTUS IK

PG/Ph.D/06/42140

UTILIZATION OF CAPITAL BUDGETING AS AN OPTIMAL TOOL FOR INVESTMENT ANALYSIS IN MANUFACTURING COMPANIES IN ENUGU AND ANAMBRA STATES

FACULTY OF EDUCATION

DEPARTMENT OF VOCATIONAL TEACHER EDUCATION (BUSINESS EDUCATION),

Paul Okeke

Digitally Signed by: Content manager’s Name DN : CN = Webmaster’s name O= University of Nigeria, Nsukka OU = Innovation Centre

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UTILIZATION OF CAPITAL BUDGETING AS AN OPTIMAL TOOL FOR INVESTMENT ANALYSIS IN MANUFACTURING COMPANIES IN E NUGU

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

APPROVAL PAGE

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This Thesis has been approved for the Department of Vocational Teacher

Education (Business Education), University of Nigeria, Nsukka.

By

_____________________ __________________ Prof. E.C. Osuala Internal Examiner Thesis Supervisor

_____________________ __________________ External Examiner Prof. C. A. Obi Thesis Supervisor Head of Department

___________________ Prof. I. Ifelunni

Dean, Faculty of Education

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CERTIFICATION

Agboh, Callistus Ik., a Postgraduate student in the Department of Vocational

Teacher Education, with Registration Number PG/Ph.D/06/42140, has satisfactorily

completed the requirements for the award of the Degree of Doctor of Philosophy

(Ph.D) in Business Education.

The work embodied in this thesis is original and has not been submitted in part

or full for any other diploma or degree of this or any other University.

_______________________ _______________________ Agboh, Callistus Ik Prof. E. C. Osuala Student Supervisor

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DEDICATION

This research work is dedicated to my late mother, Mrs. Virginia A. Agboh,

for offering her life for my education.

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ACKNOWLEDGMENT

I am particularly grateful to my thesis supervisor, Professor E. C. Osuala,

whom under his guidance this study was inspired, organized and completed. His

kindness, care, understanding, constructive criticisms and advice throughout the

various stages of this work were indispensable. I am highly elated by his fatherly role.

My heartfelt appreciation also goes to Prof. (Mrs) C. A. Obi, Prof. (Mrs) Igbo,

Prof. N. O. Ogbonnaya, Prof. (Mrs) U. N. V. Agwagah, Dr E. A. C. Etonyeaku, and

Dr (Mrs) T. C. Ogbuanya for their invaluable corrections, guidance and stimulating

academic offers which led to the successful completion of this work. The

contributions and assistance of Prof. E. E. Agomuo, Prof. A. U. Nweze, Dr R. O.

Ugwoke, Dr. (Mrs) Regina Okafor and Mr J. K. Edeh were immeasurable especially

in reading through my work and in validating the instrument for this work. Their

comments, advice and suggestions gave this work a facelift.

I am highly indebted to the management and staff of the manufacturing

companies in Enugu and Anambra States, especially those that responded to my

instrument. I am particularly grateful to Engr. C. G. Nzewi, Chairman, Anambra,

Enugu and Ebonyi States branch of Manufacturing Association of Nigeria for availing

me the necessary information for this study.

The kindness and assistance meted to me by Prof. Ben Mba, Provost, Federal

College of Education, Eha-Amufu, and my colleagues in the Department of Business

Education is also highly appreciated. I also wish to appreciate my wife, Chidimma,

my siblings, Chijioke, Fr. Denis, Ibe, Sunday and Kenechukwu; and my children,

Ebubechukwu, Nnadozie, Adaeze and Chijiekwu for their prayers and understanding

during the writing of this work. Finally, I thank Mrs Angela Eze, for typesetting this

work.

Agboh, Callistus IK Department of Vocational Teacher Education

University of Nigeria, Nsukka

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TABLE OF CONTENTS

Page

TITLE PAGE … … i

APPROVAL PAGE … … ii

CERTIFICATION … … iii

DEDICATION … … iv

ACKNOWLEDGMENT … … v

TABLE OF CONTENTS … … vi

LIST OF TABLES … … ix

LIST OF FIGURES … … xi

ABSTRACT … … xii

CHAPTER ONE: INTRODUCTION … 1

Background of the Study … … 1

Statement of the Problem … … 8

Purpose of the Study … … 9

Research Questions … … 10

Hypotheses … … 11

Significance of the Study … … 12

Delimitation of the Study … … 14

CHAPTER TWO: REVIEW OF RELATED LITERATURE 15

Conceptual Framework … … 16

• Company … … 16

• Manufacturing … … 17

• Manufacturing Company … 18

• Capital … … 21

• Investment … … 22

• Budget … … 23

• Investment Analysis … … 26

• Capital Budgeting … … 27

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• Utilization of Capital Budgeting for Investment Analysis 32

• The Need for Capital Budgeting Decision Processes in corporate planning … … 35

• Management Compliance in the use of Capital Budgeting Techniques 47

• Utilization of Capital Budgeting by Manufacturing Companies for Investment Analysis … … 72

• Outsourcing of Capital Expenditure Decisions and the Prospect of Manufacturing Companies … 77

• The Effect of Utilization of Capital Budgeting on companies earnings 81

• Constraints to Effective use of Capital Budgeting for Investment Analysis … … 99

• Strategies for Improving on the use of Effective Capital Budgeting 102

Theoretical Framework … … 111

• Quantity Theory of Money … 111

• Liquidity Premium Theory … 111

• Arbitrage Theory of Capital Assets Pricing … 112

• Utility Theory … … 113

• Portfolio Investment Theory … 115

• Dominant Theory of Budgeting … 116

Related Empirical Studies … … 119

Summary of Related Literature … … 125

CHAPTER THREE: METHODOLOGY … 128

Design of the Study … … 128

Area of the Study … … 128

Population for the Study … … 129

Sampling Technique … … 129

Instrument for Data Collection … … 130

Validation of the Instrument … … 132

Reliability of the Instrument … … 132

Method of Data Collection … … 133

Data Analysis Technique … … 134

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CHAPTER FOUR: DATA PRESENTATION AND ANALYSIS 136

Major Findings of the Study … … 153

Discussion of Major Findings … … 157

CHAPTER FIVE: SUMMARY, CONCLUSIONS AND RECOMMENDATIONS … 168

Restatement of the Problem … … 168

Summary of the Procedures Used … … 169

Summary of Findings … … 170

Conclusions … … 172

Implications for Accounting Education … 174

Recommendations … … 175

Suggestion for Further Research … … 176 REFERENCES … … 177

APPENDIX A: LETTER OF INTRODUCTION … 187

APPENDIX B: EVIDIENCE OF INSTRUMENT VALIDATION 188

APPENDIX C: QUESTIONNAIRE … 189

APPENDIX D: LIST OF URBAN AND RURAL; SMALL, MEDIUM AND LARGE SCALE MANUFACTURING COMPANIES IN ENUGU AND ANAMBRA STATES 196

APPENDIX E: POPULATION AND SAMPLE DISTRIBUTION 205

APPENDIX F: RESULT FOR RESEARCH QUESTIONS 206

APPENDIX G: RESPONSE FREQUENCIES AND PERCENTAGES 210

APPENDIX H: RESULTS OF HYPOTHESES TESTING 210

APPENDIX I: CRONBACH ALPHA RELIABILITY RESULTS FOR RESEARCH QUESTIONS 1 – 7 241

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LIST OF TABLES

Table Page

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 … … … 137

2. A t-test of the Differences between the Means of Urban and Rural Manufacturing Companies on the Extent Capital Budgeting Processes aid Corporate Planning for Long Term Survival of Manufacturing Companies … … 138

3. Mean Ratings and Standard Deviations of Respondents on the

Extent of Management Compliance to the Use of Capital Budgeting Techniques for Investment Analysis … 140

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 … … 141

5. Mean Ratings and Standard Deviations of Respondents on the

Extent Manufacturing Companies Utilize Capital Budgeting Investment Evaluation Criteria for Investment Decisions … … … 142

6. Mean Ratings and Standard Deviations of Respondents on the

Extent Manufacturing Companies Utilize Outsourcing for Capital Expenditure Decisions … … 144

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 145

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 … … … 146

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

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Investment Analysis Enhance Company’s Earnings … 147

10. Mean Ratings and Standard Deviations of Respondents on the

Constraints to Effective Use of Capital Budgeting for Investment Analysis … … … 149

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 … 150

12. Mean Ratings and Standard Deviations of Respondents on

Strategies for Improving on Effective Use of Capital Budgeting for Investment Analysis … … … 152

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LIST OF FIGURES

Figure Page

1. A Decision Making Process for Capital Investment Decision 43 2. Graphical Representation of Internal Rate of Return (IRR) Estimate 61

3. Organisation of Finance Functions in a Typical Nigerian Manufacturing Company … … … … 73

4. Schematic Representation of Conceptual Framework 109

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ABSTRACT

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 hypotheses at 0.05 level of significance. The population for the study consisted of 552 management staff of the 138 registered manufacturing companies operating in Enugu and Anambra Sates. 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 respectively. A total of 320 of the 336 copies of the questionnaire administered were retrieved representing about 95% retrieval. The data collected were analyzed using frequency, percentage and mean for answering the seven research questions while 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. The major findings of the study were: 1) capital budgeting decision processes were used to a little extent to aid corporate planning; 2) management complied to a little extent with the use of capital budgeting techniques for investment analysis; 3) balancing strategic management consideration with capital budgeting evaluative techniques will improve on effective use of capital budgeting for investment analysis. It was concluded that manufacturing companies utilized non discounted investment evaluation techniques to a great extent for investment decisions. Based on the findings and conclusion, it was recommended that management should ensure the use of discounted capital budgeting techniques for investment analysis, and allow financial managers free hand in project evaluation and selection.

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CHAPTER ONE

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.

28

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

29

• 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

30

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

31

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

32

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.

33

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

34

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.

35

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

36

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.

37

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

38

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

39

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

40

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

41

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

42

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,

43

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

44

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

45

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.

46

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

47

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

48

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

49

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,

50

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

51

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

52

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

53

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

54

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

55

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.

56

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

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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

58

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

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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.

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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

61

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

62

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

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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.

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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

65

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

66

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

67

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

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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

{N 1000 ÷ (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);

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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 = onn

3

3

221 C -

K) (1

C ...

k) (1

C

K) (1

C

k) (1

C

+++

++

70

Therefore, NPV = ott

n

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

71

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 ‘C t’ 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

72

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

73

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

74

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

75

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:

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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

n3

3

221 =

++

++

++ 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).

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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 = ott

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

78

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

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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

80

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

1tT)(1

tEBIT

+

∑−

−

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

83

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:

84

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.

85

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.

86

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

87

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).

88

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

89

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;

90

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

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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

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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

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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’ (α) and the ‘beta’ (β) 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 αt) 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

146

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?

155

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

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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

164

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.

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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

168

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

169

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

170

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

171

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.

172

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

173

money is most appropriate. This opinion is not completely in line

with the above findings of this study.

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.

174

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

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

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budgeting evaluation criteria. The findings of this study contrast the findings of

Enweluzor (2006), who assessed capital budgeting techniques and model and its

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.

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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

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.

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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

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.

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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

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

179

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,

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

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investment analysis. This finding agrees with that of Amalokwu and Ngoasong

(2008) that a good management control system that can create and sustain competitive

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%

182

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

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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.

184

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

185

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

186

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

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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

188

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.

189

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.

190

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APPENDIX A

LETTER OF INTRODUCTION

UNIVERSITY OF NIGERIA

NSUKKA CAMPUS DEPARTMENT OF VOCATIONAL TEACHER EDUCATION

TELEGRAM: UNIVERSITY NSUKKA TELEPHONE: NSUKKA 042/771911/771920 EXT 39

AGRICULTURE BUSINESS

COMPUTER EDUCATION HOME ECONOMICS

INDUSTRIAL TECHNICAL Your Ref. …………………………… Our Ref. UN/FE/VTE/98 Date: 28th March, 2010 ……………………………………….. ……………………………………….. ……………………………………….. ………………………………………..

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

201

APPENDIX B

EVIDIENCE OF INSTRUMENT VALIDATION

202

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) FO R 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 ………………….………

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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

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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.

205

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

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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

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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

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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

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APPENDIX D

LIST OF URBAN AND RURAL; SMALL, MEDIUM AND LARGE SC ALE 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.

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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.

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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.

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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.

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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.

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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.

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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.

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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.

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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.

218

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).