ABSTRACT
This research is an in-depth study of the impact of risk
on capital budgeting decisions of some selected companies in Nigeria. There
seems to be a great difference between the theoretical aspect of capital
budgeting and the actual practice. The central issue is that not enough effort
has been made to integrate both the theoretical knowledge and actual practice.
The data for study were collected from primary and secondary sources. The
primary data was collected from interviews, questionnaires and observations
while secondary data were collected from textbooks, journals etc. The
analytical approach adopted includes the frequency and percentage distribution
analysis. The chi –square method was also used in testing the hypotheses
specifically formulated for the study. From the study it was found out that:
The practice of capital budgeting in companies studied was not in line with the
theoretical models postulated, the decision making process of the companies did
not depend on the present micro-economic and government policies alone, and
thereby not solely affected by it, Well-qualified management manpower can
improve the success and growth of a firm. Based on the outcome of the study,
the researcher recommended, among others, some effort to harmonize theoretical
proposition of the academic community and actual practice applied by practicing
managers. Apparently, both sides, the academic and field men are talking to
themselves rather than to each other. What is needed is to develop the means
whereby the veritable fruit of research and studies can be applied. If this is
done, the overall ability of firms with reference to capital budgeting decision
and risks will improve tremendously for the specific benefit of the relevant
firms and the entire society at large.
CHAPTER ONE
1.0 INTRODUCTION
1.1 BACKGROUND OF THE STUDY
Capital is a very important factor in any business. It
determines the size of a business and to a large extent the performance of such
business. Capital intensity is not however all that a business needs to make
it. The investment portfolio plays a major role in the success or failure of
any business. Proper capital investment is the dream of any investor and is the
bedrock upon which the success of any business is built.
It is however evident that prudent capital investment
entails prudent capital budgeting. Proper budgeting begets well thought out
investment. To the well informed managers it implies budgeting that has been
carried out from the grassroots, involving all the persons concerned or all who
should contribute towards the realization of the budget expectations.
Capital budgeting is the process of making long-term
investment decisions that further the company’s goals.
Capital
budgeting decision is concerned with efficient investment of available funds in
long term activities with anticipation of future benefits over a series of
years, so as to exert considerable influence on the overall growth of any
economy not just that of a firm (Von Horne 1980). Companies make many financial
decisions in order to grow, including selecting product lines, disposing of
business segments, choosing to lease or buy equipment and selecting
investments. To make a long- term investment decision in accordance with the
company’s goals, three basic tasks need to be addresses in the process of evaluating
capital budgeting. The tasks include estimating the expected cash flows from
the project, estimating the cost of capital, which is sorrogate for the
required rate of return, and applying a decision rule to determine whether a
project will be worthwhile for the company
Resources such as land, machine, building, natural
resources and manpower are in short supply and have alternative uses (Von
Horne1980). These resources once committed to capital expenditure decisions of the
firm have long- term implications and influence the firm’s corporate image.
In order to achieve the goal of the firm, which is assumed
to be maximization of shareholder’s wealth, it is imperative that the impact of
risk and uncertainty should as a matter of necessity, be recognized and taken
into consideration.
The term “risk’’ has different shades of meaning.
Literally, it means exposure to danger or economic adversity. In general sense,
risk is used as a surrogate for the likelihood of loss or the potential size of
such a loss. In this context we shall use the word to denote exposure to loss
arising from variations between the expected and the actual outcome of
investment decisions (Okafor,1983)
Adjusting for risk and uncertainty in capital budgeting
involves the use of both quantitative and qualitative tools. Some of the
quantitative tools include analysis of mean and variance, accounting rate of
return, payback period and the discounted cash flow (DCF) methods such as net
present value (NPV) internal rate of return (IRR) and profitability index (PI).
It is based on the above background this research project intends to examine the impact
of risk on capital budgeting decisions.
1.2 STATEMENT
OF PROBLEM
A wide difference seems to
exist between capital budgeting theory and the actual practice. Such
inconsistency between theory and practice could be attributed to differences in
the basic concept of capital budgeting itself. These differences include
inability to capture the role of organizational structure and behavior in
corporate decision-making, failure to incorporate management’s structure and
behavior towards risk, difficulties in practice especially due to unrealistic
assumptions about data availability, and inability to in corporate strategic
considerations in decisions made by the firm. This procedure is indeed a
theoretically correct approach to a class of decisions. The problem today’s
large corporations call capital budgeting has very little to do with that class
of decisions, rather they can be seen as general management problems. Also the
process by which resources are committed to turn involve (1) intellectual
activities of perception, analysis, and choice which are often sub- summed
under the decision making; (2) the social
process of implementing formulated policies by means of organizational
structure, systems of measurement and allocation, and systems for reward and
punishment, and finally (3) the dynamic process of revising policy as changes
in organizational resources and the environment change. The context of the
original policy problem and management of these processes is a task for general
management rather than financial specialist , because clearly no one manager
can be assumed to have the knowledge or time to generate the detailed programs
to use these funds as well as the acquiring of capital funds.
External environmental factors constitute other problems
because business organizations are continually faced with the problem of
deciding whether to commit resources or not.
Another problem is inadequate investment analysis in spite
of the fact that the procedures used to help management make investment
decisions often are inadequate and misleading.
Finally, in an economy like Nigeria where the investor is
faced with unique and qualitative risk due to instability of government
policies and risk mismanagement of resources
among others. Also, because a
lot of businesses get involved in projects for which they lack qualified
management capacity to explicitly manage the risk exposure involved.
The central issue is that not enough efforts has been made
to integrate both the theoretical knowledge and the actual capital budgeting
practice which if properly applied (theories and techniques) by well informed
managers will help them make better decisions whether under conditions of
certainty, uncertainty and condition of risk.
Based on the above discussion of the problems a number of
research questions have been developed.
1.3 RESEARCH
QUESTIONS
(1)
Do the capital budgeting procedures
adopted by companies conform to the theoretical postulates for the procedures?
(2)
How is the effectiveness of
the decision –making process of a firm, affected by the organizational
structure and management manpower?
(3)
What are the appropriate investment
analytical tools to be applied in evaluating a particular business?
(4)
Do the present micro-economic
government policies promote/inhibit long-term investment decision-making?
(5)
To what extent can qualified
management manpower impact on the success of a business?
1.4 OBJECTIVES OF THE STUDY
The researcher intends to
make in-depth study of the impact of risk on capital budgeting decisions of
selected companies in Nigeria. The objectives among others include
1.
To find out if company’s practice
of capital budgeting is in line with the theoretical models postulated
2.
To identity the major
environmental peculiarities of Nigeria, which affect the environment in capital
budgeting, decision.
3.
To assess the impact of qualified
management manpower on the success of a business.
4.
To make recommendations on how to
adequately predict/ incorporate the impact of risk on capital budgeting
decision so as to enhance the fortunes of the affected firms in particular and
the economy in general.
The
following hypothesis are formulated in null form
Ho— Investment decisions of a firm do not depend on the
prevailing economic and government policies.
Ho—Qualified management manpower does not add to the
success of the business
Ho—Proper investment/ project evaluation does not minimize
risk of project failure.
The above Hypothesis will be tested using the chi- square
(x2) statistical method. The result will either uphold the null or
the alternative hypothesis.
1.6
SCOPE OF THE STUDY
The aim of the research is to gain a better understanding
on the need to properly evaluate a project before take-off in order to reduce
the impact of risk/ uncertainties. Since the research problems are many, the
researcher has tried to narrow the focus down by using data generated from a
few petroleum service companies in Anambra State.
1.7 SIGNIFICANCE OF THE STUDY
This study is undertaken on the basic assumption that risk
plays a disproportionate role in effective capital budgeting decision, and that
capital budgeting, if adequately formulated and executed will enhance the
realization of the set objectives of the relevant firm. On these premises
therefore, this study will be of immense benefit to management in several
areas:
1.
Since capital budgeting
decision is critical to the success of any business its knowledge is necessary
to aid decision making by management of any organization.
2.
The study would lead to the
understanding and awareness of the fact that capital budgeting theory and
practices are affected by environmental factors; this will enable one not to
accept as sacrosanct theoretical postulations without consideration of the
operating environment.
3.
In this era of liquidity
squeeze (high cost of capital) in Nigeria, it is important for businessmen to
be grounded on the necessity and benefits of capital budgeting to enable them
to make optimal decisions. Consequently, managers, investors
4.
The study will be of immense
benefit to emerging entrepreneurs, students and researchers in capital
budgeting and risk.
5.
It will serve as reference
point for future study and research in the area of capital budgeting decision.
6.
It is hoped that the result
of the study will stimulate more extensive and exhaustive study on the subject
matter in Nigeria’s context.
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Item Type: Project Material | Size: 94 pages | Chapters: 1-5
Format: MS Word | Delivery: Within 30Mins.
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