CRITICAL ASSESSMENT OF CAPITAL BUDGETING DECISION IN MANUFACTURING COMPANY
|BANKING AND FINANCE|
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1.1 BACKGROUND OF THE STUDY
Capital budgeting is the process by which the financial manager decides whether to invest in specific capital projects or assets.
In some situation, the process may entail in acquiring assets that are completely new to the firm. Other situations,it may mean replacing on existing obsolete asset to maintain efficiency.
During the capital budgeting process answers to the following questions are sought.
What project are good investment opportunities to the firm?from this group which assets are the most desirable to acquire?
How much should the firm invest in each of these assets?
COMPONENTS OF CAPITAL BUDGETING
Initial investment outlay: it includes the cash required to acquire the new equipment or bold the new plant less any net cash proceed from the disposal of the replaced equipment. The initial outlay also includes any additional working capital related to new equipment.
Only changes that occurs at the beginning of the project are included as part of the initial investment outlay.
Additional working capital needed or no longer needed in a future period is accounted for as a cash outlay or cash in flow during that period.
Net cash benefits of savings from the operation.
This component is calculated as under: (The incremental change in operating revenue minus the incremental change in the operating cost Incremental net revenue) minus (taxes) plus or minus (changes in the working capital and other adjustments)
Terminal cash flow: it includes the net cash generated from the sale of asset, tax effects from the terminal of the asset and the release of net working capital.
The net present value technique, although these are several methods used in capital budgeting, the Net present value technique is more commonly used under this method a project with a positive NPV implies that at is worth investing in.
All business decisions involved a choice among alternative courses of action.
The criteria for such choices may be subjective, such as attitudes of employees or the may be objective such as dollars/ Naira of cost and revenue.
Most decisions are influenced by a combination of both subjective and objective factors.
In most situations, it as possible to analyze some of the consequence of alternative actions in quantitative terms and to use the result of the analysis and making a decision.
If two alternative actions are under consideration, quantitative analysis will generally show which actions will lead to the higher profit or if an investment return on investment may be expressed as the ratio of income per period to the average investment for the period to the average investments for the period.
Since income change either in revenue or in cost is relevant to the decision.
If a decision involves a new investment that will be recovered through increased net revenue or cost savings over a period of several years, an analysis of cash flows overtime is present value computation outline of an alternative choice problem is formulated through the following steps.
– Defined the problem and identify the alternative solution to be considered
– Measures and compare the consequence of each alternative,in so far as these consequences can be express quantitatively.
– Evaluate the subjective factors and considered the extent to which they offset quantitative considerations
– Arrive at a decision
Perhaps the most common alternative choice problem involves decision for replacement of plant assets or expansion of productive facilities.
The process of planning and evaluating proposals for investment in assets is called CAPITAL BUDGETING.
Capital budgeting is complicated by the fact that the decision must be made for estimate of future operating result which by their nature involve a considerable degree of uncertainty.
Yet these decisions are crucial to the long-run financial health of a business enterprise.
Not only are large amount of money committed for long period of time, but many capital budgeting decisions are difficult or impossible to reverse once the funds have been committed and their projects as begun.
Thus companies may benefits from good capital budgeting decisions and suffer from poor ones for many years.
Many non-financial factors are considered in making capital budgeting decision e.g. many companies give high priority to creating jobs and avoiding layoffs.
However it is also essential that investments in plant assets earn a satisfactory return on the fund invested.
Without this return, investors will not be able to generate sufficient funds for future investment projects.
Capital budgeting is a broad field involving many sophisticated techniques for evaluating the financial and non-financial considerations capital expenditures differ from day to day revenue expenditure because of the following.
1. The involve large outlay
2. The benefits will accrue over a long period of time, usually well over one year and often much larger, so that the benefits cannot all be set against costs in the current year’s P and L account.
3. They are very risky
4. They involve irreversible decision
According to oye Akinsulire (2005): capital budgeting involves all investment tin long-term projects.
It is the process of selecting alternative long term investment opportunities i.e. It is the process of committing the company’s fund into long term projects.
These projects would normally have life spans exceeding one accounting period.
The procedures involved in capital budgeting decisions are as follows:
• Identification of possible projects (investments profile)
• Evaluation of projects
• Authorization of projects
• Development stage
• Monitoring and control of projects
• Post audit.
A very important part of a management accounting job is to provide information will assist the making decision concerning the investment of capital funds.
This is the process known as capital budgeting.
Hence, we need to evaluate every investment proposal to use if it is viable or not. In making such decision, analyst must be very careful because capital budgeting usually involves a lot of money and cannot be spent in an haphazard way.
1.2 STATEMENT OF THE PROBLEM
Financial advisers and invent managers are faced with so many problems and do not have absolute authority in discharging their responsibilities their actions are constrained by certain factors beyond their control.
There are two distinct factors which exert very strong influence over budgeting decision making process individual and corporate investors carrying out their investment business in line with the legal framework and in confronting with the nation’s economy.
Therefore, there are internal environment which refers to internal structure of the firm and those that exists that is external environment.
The internal environment addressed the inadequacy of human resources as one of the most principals factors where as the external environment includes factors such as the political economics cultural, social, legal and technological framework within which the firm operates.
Capital budgeting decisions are further compounded by the high rate of inflation in Nigeria economy, the nature and size of the projects in question and decision maker is the value judgment and his skill and expertise as well as liquidity constraints.
The research shows among other things that capital budgeting techniques are very vital and important in organizational flexibility, profitability, applicability and reliability in taking decision.
1.3 AIMS AND OBJECTIVES OF THE STUDY
The aim of this research is to under study the capital budgeting decision in manufacturing company taken vital-foam Nigeria plc, as the case study.
To achieve the above aims therefore, the following objectives will be taken into consideration.
To reveal the risks and uncertainty inherent proposal
To determine the profitability of an investment proposal
To determine factors affecting capital budgeting decisions
To reveal other quantitative factors affecting capital budgeting decisions.
To determine whether the investment is worthwhile undertaking or not.