THE IMPACT OF CAPITAL BUDGETING IN THE PRIVATE SECTOR (using your branch as a case study)

CHAPTER ONE

1.0     INTRODUCTION

1.1     BACKGROUND OF THE STUDY 

Every business firm normally will like to know how it perform over a period of time this leading to a preparation of profit and loss statement. They also ask about their position at a particular point in time, which lead them to the preparation of budget. A budget can be seen as a document or financial document used to project future income and expenses. In budgeting there are types of budget prepared by the firms, such as capital budget, sales budget and cash budget and so on. The process of preparing capital budget is called budgeting. Capital budget are long-term budget made for acquisition and expansion of fixed asset. Many firms prepares capital budget today, it was originated in the United states of America (U.S.A). In America it was applied by all firms before the second world war. After the second World War many firm saw the need to plan for capital expenditure, hence it is prevalence today. The Nigeria brewery limited and other beverage are not left out in the train of firm that prepare budget for its capital expenditure. The process of capital budgeting is vital to any responsible, well managed business. if that business is public and owned by public shareholders, the budgeting process becomes more crucial, since shareholders can hold management accountable for accepting unprofitable projects that can have the effect of destroying shareholder value. The decision of whether to accept or deny an investment project as part of a company’s growth initiatives, involves determining the investment rate of return that such a project will generate. Capital budgeting is also vital to a business because it creates a structured step by step process that enables a company to develop and formulate long-term strategic goals, seek out new investment projects, estimate and forecast future cash flows, facilitate the transfer of information and creation of decision. Capital budget however is not easy as it is fought with a lot of problems.

  • STATEMENT OF THE PROBLEM

The main purpose of setting up a private firm is to achieve enough sale revenue that will cover the fixed and the variable cost as well as live some profit to justify its existence. The introduction of many economic measures after the year 1982 aim at revamping the nations economic comes with many problem with which the brewery industries are not left out.

  1. The problem of change in the demand of beer.

In order to produce, firms in the brewery industry including (The Nigeria brewery limited) acquire fixed assets as well as raw material. This acquisition is based on the expected demand. The demand of beer can not now be fairly estimated because of the general rises in the price. General rise in the price of beer has made the customers to shift their demand to other goods. These bring about decrease in the demand for beer. The uncertainty surrounding the continuance rate at which the demand of beer decrease has become of the problem encountered by the capital budget especially by the Nigeria breweries limited since the capacity of the production is always affected by the change in the demand of product.

  • The problem of tariff and import restriction on the importation of fixed asset and the spare parts.

It has made the firm like the Nigeria brewery limited look of alternative way of obtaining fixed asset necessary for its production and operation. It often increased the price for them as a result of the import tariff restriction. The uncertain surrounding this has made capital budget a problem.

  1. The problem of appropriate selection of human factory which is the fidelity of the capital budgeting

4       The problem encountered in the external source of financing in its capital project.

The external source of financing included the commercial banks, trade   creditors and some financial institution. Banks and other financial institutions charges interest on the money that they lend out, interest charges fluctuated with the changes in economic setting. Due to the dynamic nature of the economic with consequent effect on the interest rate, it is problem making cost benefit analysis, necessary in the capital budgeting. The rate is never stable. The uncertainty include in this makes a problem for capital budgeting.

  1. Problems on knowledge of the techniques in project evaluation.

1.3     OBJECTIVES OF THE STUDY

The general objectives of capital budgeting are

  • To determine the product scope, capital budgeting lets project planners define the financial scope of a project.
  • To determine funding sources and how much money will be needed form each source and the costs associated with using that funding method.
  • To control project costs, capital budgets act as control document throughout the life of the project.
  • To determine payback time, an important element of capital budgeting is determining the project time.

While the objective of this study is to find out the following.

  • To find out the extent to which capital evaluation techniques are used by the Nigeria breweries management in evaluating their projects.
  • To find out whether evaluated projects will yield adequate return for the investors.
  • To determine the factor that influence the selection of project to be invested in .
  • To determine the extent in which evaluation of capital important in Nigeria budgeting.
  • To find out if appropriate selection of human factory, is the fidelity of the capital budgeting.

1.4     RESEARCH QUESTION

The following questions have been formulated as a guide for this research.

  • Do Nigeria breweries management use capital evaluation techniques in evaluating their project?
  • To what extent does evaluated project yield adequate return for investors?
  • What are the factors that influenced the selection of project to be invested in?
  • To what extent is evaluation of capital project important in NBC budgeting?
  • Is the appropriate selection of human factory the fidelity of the capital budgeting?

1.5     RESEARCH HYPOTHESIS:

The hypotheses of this research are stated below:

1       HO: Nigerian breweries managements does not use capital evaluation techniques in evaluating their project.

HA: Nigerian breweries management use capital evaluation techniques in evaluating their project.

2       HO: Evaluated project do not yield adequate return for investors.

HA: Evaluated project yield adequate return for investors

3       Ho: There are no other factors which influence the selecting of project to be invested in

HA: Ho: There are other factors which influence the selecting of project to be invested in

4       HO: Evaluation of capital is not important in Nigeria budgeting.

HA: Evaluation of capital is important in Nigeria budgeting.

5       Ho: Appropriate selection of human factory is not the fidelity of the capital budgeting

HA: Appropriate selection of human factory is the fidelity of the capital budgeting

1.6     SIGNIFICANCE OF THE STUDY

The outcome of the research work will be significant to the management of the Nigeria breweries Limited who is faced with capital budgeting decision problem. Furthermore, it will be significant to the investors who wish to invest in capital project.

Finally it will equally be important to other researchers and scholars who may wish to carry out further research on the subject matter or on the related topic.

1.7     SCOPE OF THE STUDY

The study will examine the capital budgeting techniques of the Nigeria breweries and will be able to establish techniques adopted by the firm stated in the theory. The study will also examine the extent in which evaluation of capital important in Nigeria budgeting and also whether evaluated projects will yield adequate return for the investors.

1.8     OPERATIONAL DEFINITION OF TERMS

CAPITAL BUDGETING: This is the long term plan made for production, necessary to buy fixed asset for the production of the goods and services.

Finance: This is the term used to donate acquisition and spending of fund to met an economic unit objective

Cash flow: This is the asset of long-term nature used in the production of goods.

Capital rationing: This is the allocation of scarce capital resources among competing economically desirable projects, which cannot be carried out to capital or other constraint.

Ranking: This is the arranging of project in other of their viability with reference to the evaluation result.

Capital expenditure: This is the investment to acquire fixed or long-lived assets from which a stream of benefits is expected

Budget: This is the plan that is qualified in a monetary term

Private sector: This is the part of the economy sometimes referred to as the citizen sector which is run by private individuals or groups.

CHAPTER TWO

2.0     LITERATAURE REVIEW

2.1     INTRODUCTION:

capital budgeting originated from the united state of America. It was applied by all firms before the second world war. After the second world war, many firm saw the need to plan for capital expenditure, hence it is prevalence today. The Nigeria brewery Limited and other beverage are not left out in the train of firm that prepare budget for its capital expenditure.

Capital expenditure is any significant expenditure incurred to acquire or improve land, building, engineering structures, machinery and equipment. It normally confers a benefit lasting beyond one year and results or the acquisition of extension of the life of a fixed asset. Capital budgeting in

Making decisions have significant future benefits or cost or various entities and their stakeholders.

Capital budgeting is a multi-year financial plan, usually five or ten years for the constructions or acquisition of capital work. The plan, once complete, should provide for the planning of future financial resources required to finance the project, identify the future financial resources to allocate from the operating (revenue fund) budget to operate and maintain the capital asset once it is acquired and integrated with Nigeria breweries on going management control system.

Capital budget is distinguished from an operating budget. An operating budget normally provides for the day to day expenditures of Nigeria breweries, for items such as salaries, wages, benefits maintenance of building and infrastructure etc. while capital budget plans for the acquisition or rehabilitation of capital assets.

  • THEORETICAL FRAMEWORK

MEANING OF CAPITAL BUDGETING

Capital budgeting is long-term planning for making and financing proposed capital out lays, it is concerned with allocation of the firms scarce financial resources among the available market opportunities. The considerations of investment opportunities involve the comparison of the expected future streams of earnings from a project with immediate and subsequent streams of expenditure for it.

FEATURES OF CAPITAL BUDGETING

The important features, which distinguish capital budgeting decision in other day to day decision, are:

  • Capital budgeting decision involves the exchange of current funds for the benefits to be achieved in future
  • The futures benefits are expected and are to be realized over a series of years.
  • The funds are invested in non-flexible long-term funds.
  • They have a long term and significant effect on the profitability of the concern.
  • They involve huge funds.
  • They are irreversible decision

IMPORTANCE OF CAPITAL BUDGETING

The importance of capital budgeting can be understood form the fact that an unsound investment decision may prove to be fatal to the very existence of the organization. The importance of capital budgeting arises mainly due to the following.

  1. Large investment: Capital budgeting decision, generally involves

Large investment of funds. But the funds available with the firm are scarce and the demand for funds exceeds resources. Hence, it is very important for a firm to plan and control its capital expenditure.

  1. Long-term commitment of Funds: Capital expenditure involves not only large amount of funds but also funds for long-term or permanent basis. The long-term commitment of funds increases the financial risk involved in the investment decision.

3       Irreversible nature: The capital expenditure decisions are irreversible in nature. Once, the decision for acquiring a permanent asset is taken, it becomes very difficult to dispose off the assets without incurring heavy losses.

4       Long-term effect on profitability: Capital budgeting decision has a long-term and significant effect on the profitability of a company. Not only the present earning of the firm are affected but also the future growth and profitability of the firm upon the investment decision taken today. Capital budgeting has utmost importance to avoid over poor under investment in fixed assets.

5       National importance: Investment decision though taken by individuals concern is of national importance because it determines employment, economic activities and economic growth.

TYPES OF CAPITAL BUDGETING DECISION

There are many ways for classifying investment. One of the classifications according to Benjamin C. Osisioma (2000) is as follows:

1       Replacement: Decision necessary to replace worn-out or damage equipment fall in the group. The purpose of such investment decision is to lower maintenance cost, minimize the decision to lower the maintained cost, minimize the marketing cost and labor cost and other variable cost item like the electricity bill.

2       Expansion of the existing product or market: Included in those categories is the expenditure to increase the output of the existing products or to expand outlet of the existing products or to expand outlet or the distribution facility in marketing new product being selected.

3       Environmental Safety Regulation: This involves expenditure necessary for the compliance with the government regulation, labour union requirements and the condition of the insurance policy. This are usually referred to as mandatory investment and non-revenue yielding project.

4       Miscellaneous expenditure: These include expenditure on office building, packing lost and similar cash outlays based on the interrelationship among proposed project.

Benjamin C. Osisioma (2000) further classifies investment decision as;

  1. Independent projects: This exists when acceptance or the rejects of the project does not affect the cash flow of another project. In other words, proposed budget save different purpose and do not compete with each other.

b       Dependent Projects: This is the reverse of the independent projects, it occur whenever the cash flow of a project affects or is influenced by the cash flow of another project and may appear in the following situation.

  1. i) Mutually exclusive project: If the acceptances of one project include the acceptance of another project. The two projects are mutually exclusive project.
  2. ii) Complementary projects: If the acceptance of one project enhances the cash flow of another project. The two projects are complementary.

iii)     Prerequisite of contingent project: If the acceptance of one project depends upon the prior acceptance of another project, the acceptance of the former is the prerequisite to the acceptance of the latter.

  1. iv) Mandatory project: This is the project that must be accepted if the firm must remain in the business. The telephone manufactured the receiver, cable and other component parts.
  2. v) Discretionary Project: These are project that are acceptable only if they are financially attractive 

PROBLEMS OF CAPITAL BUDGETING DECISION

Douglas Garbatto (2002) said that manager who is budgeting for capital expenditure are traced with whole series of problem which can be dealt with under this headings.

  • The demand for capital
  • The supply of capital
  • The timing of investment

The researcher decided to write using the above heading in addition to other. The first to be treated is the demand for capital or financial capital as J.F Weston and E.F. Brigton (2006) has it

1       The demand for capital (financial forecasting): Him Levy and Marshall Sarnat (2003) stated that at the end of every year, every company would like to know what their next year income statement and balance sheet would look like, with regard to this reach department of the company will like to estimate its total requirement for the next year operation, they stated also that they will need to know how many additional machine will be required J.F Weston and E.F. Brighton agree with the view made by Haim Levy and Marshall Sarnat but add this to often necessitate by increase in the sale forecast.

2       The supply of capital: There are many source of capital to meet the financing of capital asset needed for the increasing, such sources of fund include the bank, financial and insurance companies to mention but few. Fund can be raised from the sourcing of common stock, preferred stocks, bonds, convertible bonds and so on. The firm can also make use of the retain earning where it is much to finance its capital project.

3       The timing of investment: Don T. Decoster et al (2008) said that after the funds has be expanded the project is put in services as well as the rounded capital expenditure programmed will focus on a positive audit of the investment Charles T. Horngren and George Foster (2007) with the above statement. Both set of auditing is guided by the following reasons (integrated) for post auditing investment in capital project.

i        It foster a sense of responsibility in the originator of capital investment program.

Ii       To see that spending and specific conform to the plan as approved.

Iii      To increase the likelihood that capital spending request are sharply conceived and honestly estimated.

iv       To direct the management intention to the unsuccessful project so that additional action may be taking to attain the placed performance.

v       To improve the estimation on the future capital building projects.

vi       To gain experience in evaluating, selecting and approving future capital expenditure proposal.

TECHNIQUES USE IN CAPITAL BUDGETING DECISION

There are many techniques or methods used in investigating the use of capital in capital project. These methods include pay back period, net present value, internal rate of return, accounting rate or simple rate of return and profitability index.

  1. Payback period method: These refer to the period of time required for the return on investment to repay the sum of the original investment for example, a N1000 investment which returned N500 per year would have a two year pay back period. The time value of money is not taken into account. Payback period intuitively measures how long something takes to pay for itself. Payback period as a tool of analysis is often used because it is easy to apply and easy to understand for most individuals regardless of academic training or field of endeavor.

2       Net Present Value Method: This is the difference between the present value of cash inflows and the present value of cash outflows. NPV is used in capital budgeting to analyze the profitability of an investment or project. NPV analysis is sensitive to the reliability of future cash inflows that an investment or project will yield. Douglas Garbult (2002) said that the present value of a project is found by discounting all future cash flow at a stipulated discount rate.

3       Internal rate of return: This is the discount rate often used in capital budgeting that makes the net present value of all cash flows of a particular project equal to zero. Generally speaking, the higher a project’s internal rate of return, the more desirable it is to undertake the project. as such internal rate of return (IRR) can be use to rank several prospective projects a firm is considering. Assuming all other factors are equal among the various projects, the projects with the higher IRR would probably be considered the best and undertaken first.

4       Accounting rate or simple rate of return: This is another method in capital budgeting technique that does not involve discounted cash flow. Unlike the other capital budgeting method, the accounting rate of return method does not focus on cash flows rather it focuses on accounting net operating income. The approach is to estimate the revenue that will be generated by a proposed investment and then to deduct from these revenues of all the projected expenses associated with the project.

5       Profitability Index (P.I.): This is also known as profit investment ratio (P.I.R) and value investment of a proposed project. It is a useful tool for making projects because it allows you to qualify the amount of value created per unit of investment. Charles T. Horngren and George Foster (2007). Pointed out that some author use the profitability index in ranking project in the ascending order of profitability. The profitability index is the total value for the future; stated that if the capital rationing does not exist and if there are mutually exclusive or indivisible project, the ranking by index and net present value will produce the same answer.

2.3     CURRENT LITERATURE BASED ON THE VARIABALES

According to Mr. Aguolu (1998) capital budgeting decision is that financial decision, involving an outlay of funds in the present time and in the future.

According to the International Federation of accountants (IFAC). Capital expenditure is the investment to acquire fixed or long lived assets from which a stream of benefits is expected. Such expenditure represents an organization’s commitment to produce and sell future projects and engage in other activities.

According to Douglas Garbult (2002). The payback period is the length of time required for cash return form the project to equal the total initial cash outlay. Charles T. Horngren and George Foster (2007) defines the net present value (NPV) as the present value of all future return discounted at an appropriate cost of capital minus the cost for the investment

Halm Levy and Sarnat Marshall (2003). Defines internal rate of return as the rate of discount, which equate the present value of the expected cash flow with the initial investment outlay.

Longman dictionary defines budget as the plan that is qualified in a monetary term, while capital budgeting is a long-term plan made for expenditure necessary to buy fixed asset for the production of the goods and services.

Business dictionary: Defines capital budgeting as a plan for raising large and long-term sums greater than the period considered under an operating budget.

Investopedia.com,: Defines capital budgeting as the process in which a business determines whether projects such as building a new plant or investment in a long-term ventures are with pursuing.

According to Duncan Williamson (2012) capital budgeting relates to the investment in assets or an organization that is relatively large. This is, a new asset or project will amount in value to a significant proportion of the total assets of the organization.

According to Dr. P. Shanmukha Rao (2010). The term capital budgeting refers to long-germ planning for proposed capital outlay and their financing. It includes raising long-term funds and their utilization.

It is the firm’s formal process of acquisition and investment of capital. it may also be defined as the decision making process by which a from evaluate the purchase of major fixed assets”.

According to Rene Storm (2008)” A budget is a document containing a preliminary approved plan of public revenues and expenditure”.

According to Brian Bass demand Media (2009). Capital budgeting determines the worthiness of the project and helps a business determine if it will yield a return satisfactory to its managers and investors.

2.4     SUMMARY OF THE LITERATURE REVIEW

In summary, this research work has been able to show the origin of capital budgeting its theoretical framework and current literature based on the variables which shoes the impact of capital budgeting in a private sector to achieve what is called capital rationing. Capital rationing has to do with acquisition of new investment. More to the point capital rationing is all about the acquisition of new investment based on such factors as the rent performance of other capital investments, the amount of the asset. Capital rationing is strategy employed by companies to make investment based on the current relevant circumstances of the company. Generally; capital rationing is utilized as a means of putting a limited or cap on the portion of the existing budget that may be used in acquiring a new asset. As part of this process, the investor will also want to consider the use of a high cost of capital when thinking in terms of the outcome of the act of acquiring a particular asset. Obviously, any responsible company will choose to employ strategies that support the productive use of disposable funds build within a capital budget. Sometimes, it is important to understand what benefits can reasonably be expected from owning the asset in question.

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