ASSESSING THE NEXUS BETWEEN CAPITAL BUDGETING AND PERFORMANCE OF CORPORATE ENTITIES

CHAPTER ONE

INTRODUCTION

1.1 Background Of The Study

An efficient economic system calls for a dependable mechanism to allocate its resources. Christy (1966) describes that land, labour and capital are to be directed to their best uses, and should hence be placed in the hands of those who can use them most capably. In a market economy, this allocation process consists largely of a set of private decisions, which are directed by a network of free markets and flexible prices . Important among these decisions are capital investments decisions that according to Northcott (1995) are vital at two levels: for the future operability of the individual firm making the investment, and for the economy of the nation as a whole. At the firm level, capital investment decisions have implications for many aspects of operations, and often exert a crucial impact on survival, profitability and growth. At the national level, the proper planning and allocation of capital investment are essential to an efficient utilisation of other resources, poorly placed investment reduces the productivity of labour and materials and sets a lower ceiling on the economy’s potential output. With this in mind it is no wonder that capital investment or capital budgeting is a central application of financial theory .the advantages and applications of sophisticated capital budgeting procedures based on cash flows, risk and the time value of money are seen as tools for maximising shareholders’ wealth, which is the same as maximising the value of the firm (Copeland & Weston, 1992). This fact is often approximated to the relationship that firms using more sophisticated capital budgeting procedures should be able to perform better over time (Christy, 1966; Klammer, 1973). Empirical studies concerning the adoption of sophisticated capital budgeting procedures have shown that even though the degree of adoption has increased over time, there is an obvious “theory-practice gap” (Klammer, 1972; Schall, Sundem & Geijsbeek, 1978; and Graham & Harvey, 2001).

The research therefore seek to evaluate capital budgeting and performance of corporate entities.

1.2 Statement Of The Problem

Investment on capital project constitute a major financial budget of a firm. Therefore it is pivotal that it impacts positively on the firms performance in terms of profitability, market share, growth and shareholders value.

However many organization make huge capital investment without exacting Positive result on the firms operations. This is as a result of lack of proper Appraisal to determine the relative worth of such investment. Capital budgeting is the process in which a business determines whether projects such as building a new plant or investing in a long-term venture are worth pursuing. Oftentimes, a prospective project’s lifetime cash inflows and outflows are assessed in order to determine whether the returns generated meet a sufficient target .Also known as “investment appraisal. Ideally, businesses should pursue all projects and opportunities that enhance shareholder value. However, because the amount of capital available at any given time for new projects is limited, management needs to use capital budgeting techniques to determine which projects will yield the most return over an applicable period of time. Popular methods of capital budgeting include net present value (NPV), internal rate of return (IRR), discounted cash flow (DCF) and payback period.

Therefore the problem confronting the research is to determine capital budgeting and performance of corporate entities.

1.3 Objective Of The Study

The overall aim of this study is to critically examine capital budgeting and performance of corporate entities. Hence, the study will be channeled to the following specific objectives;

1. Find out if the use of non-discounted capital budgeting techniques return has an impact on the enhancement of the performance of the firm.

2. Find out if the adoption of net present value (NPV) method of investment appraisal has an impact on the enhancement of the performance of the firm.

3. Find out if the use of internal rate of return (IRR) has an impact on the enhancement of the performance of the firm.

4. Find out if the characteristics of capital budgeting of project has an impact on the enhancement of the performance of the firm.

1.4 Research Question

The study will be guided by the following questions;

1. Does the use of non-discounted capital budgeting techniques return have an impact on the enhancement of the performance of the firm?

2. Does the adoption of net present value (NPV) method of investment appraisal have an impact on the enhancement of the performance of the firm?

3. Does the use of internal rate of return (IRR) have an impact on the enhancement of the performance of the firm?

4. Does the characteristics of capital budgeting of project have an impact on the enhancement of the performance of the firm?

1.6 Statement Of Hypothesis

Ho1: There exists no significant relationship between the use of non-discounted capital budgeting techniques return have and the enhancement of the performance of the firm.

Ho2: There exists no significant relationship between the adoption of net present value (NPV) method of investment appraisal and the enhancement of the performance of the firm.

Ho3: There exists no significant relationship between the use of internal rate of return (IRR) and the enhancement of the performance of the firm.

Ho4: There exists no significant relationship between the characteristics of capital budgeting of project and the enhancement of the performance of the firm.

1.6 Significance Of The Study

This aspect of the work deals on the possible benefits derivable by well known and interested readers of this work. Even though the significance of capital budgeting cannot be over emphasized, but for the purpose of the information, this research work tends to convey and consequently for the purpose of simplification. Some other important significance of capital budgeting are as follows:

i) Capital budgeting which is the main bases of this study will help project investors and potential investors to know the best project to embark upon.

ii) This study also helps to reveal the need and importance of capital budgeting in investment projects.

iii) This study is also relevant as it provides the necessary knowledge on the techniques of capital budgeting.

iv) This study also will help any interested reader to know the possible risk associated with capital budgeting and how they can be minimized or possibly eliminated.

Consequently, the following persons will benefits immensely from this work.

i. The investors and potential investors

ii. The government

iii. The banks and other loan granting institutions

iv. The students

v. The general public.

1.7 Scope Of The Study

The study focuses on the evaluation of the impact of capital budgeting on organizational performance with a case study of the Ondo State Ministry of works.

1.7 Limitation Of The Study

Like in every human endeavour, the researcher encountered slight constraints while carrying out the study. Insufficient funds tend to impede the efficiency of the researcher in sourcing for the relevant materials, literature, or information and in the process of data collection, which is why the researcher resorted to a limited choice of sample size. More so, the researcher simultaneously engaged in this study with other academic work. As a result, the amount of time spent on research will be reduced.

Moreover, the case study method utilized in the study posed some challenges to the investigator including the possibility of biases and poor judgment of issues. However, the investigator relied on respect for the general principles of procedures, justice, fairness, objectivity in observation and recording, and weighing of evidence to overcome the challenges.

1.9 Definition Of Terms

Capital Budgeting Defined

Capital budgeting is the process in which a business determines whether projects such asbuilding a new plant or investing in a long-term venture are worth pursuing. Oftentimes, a prospective project’s lifetime cash inflows and outflows are assessed in order to determine whether the returns generated meet a sufficient target .Also known as “investment appraisal. Ideally, businesses should pursue all projects and opportunities that enhance shareholder value. However, because the amount of capital available at any given time for new projects is limited, management needs to use capital budgeting techniques to determine which projects will yield the most return over an applicable period of time. Popular methods of capital budgeting include net present value (NPV),internal rate of return (IRR),discounted cash flow (DCF) and payback period

Organisational Performance Defined

organization performance relates to how successfully an organised group of people with a particular purpose perform a function. Essentially, this is what we are speaking about when we refer to organisational performance and achievement of successful outcomes. High organisational performance is when all the parts of an organisation work together to achieve great results with results being measured in terms of the value we deliver to customers.

Strategic Objectives

Provide the direction in which everyone within the organisation should head. They provide focus and ensure we are all working towards the same end.

Organisational Structure

This represents the form in which the organisation will deliver its services. The structure must support the strategy just as the strategy must have regard to the structure. For instance, an on-line delivery strategy will not be successfully executed unless the organisation has on-line capabilities.

Business Performance Measures

Represent the measures by which each area of the organisation will be assessed. There is no single set of measures that may be applied across all organisations. In order to be relevant and of use to the organisation, the measures must be determined in light of the organisation’s goals and the strategies put in place to achieve those goals. It is this measurement process that will direct behaviour more than any other system that may be put in place. Further, the information must be easily obtainable – in a timely manner. This requires the management information systems to be developed to collect the right data in an efficient way.

Allocation Of Resources And Processes

Relates to the decision making approach that takes place within the organisation. It is how the organisation goes about deciding where to apply its scarce resources – including money, time and effort – in order to achieve its objectives.

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