Capital Budgeting Decision In Manufacturing Company (A Case Study Of Vital Foam Nigeria Plc Lagos)
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 absolete 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 quantiitative terms and to use the result of the analysis an 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.
- The involve large outlay
- 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.
- They are very risky
- 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 audit and control of projects
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 string 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 nations 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.
1.4 Research Question
In the course of this research study the respondents will be able to answer to these questions.
- What are capital budgeting decision?
- Why and how does manufacturing company get involved in capital budgeting decision?
- Is there a consensus in the choice of capital budgeting evaluation or appraisal techniques in manufacturing company?
- How do the manufacturing concerns acquire data relevant for capital budgeting decision making?
- What role does uncertainty play in investment decision?
1.5 Research Hypothesis
In order to arrive at logical conclusion on this research study the following hypotheses will be considered.
- Hi: Capital budgeting decision has no significant influence on the success of an investment outlay.
Ho: Capital budgeting decision has significant influence on the success of an investment outlay
- Ho: Capital budgeting decision is not indepednet on the relevant data acquired
Hi: Capital budgeting decision is independent on the relevant data acquired
1.6 Significant of the Study
It has been established that capital budgeting decision are inevitable due to their effect on effectiveness and efficiency in manufacturing company in Nigeria business. This study is attempt towards achieving its aims stakeholders will then be at an advantage to make reasonable and rational decision based on the finding conclusion and recommendations of the study.
1.7 Scope and Limitation of the Study
This work focuses on medium long term investment. It is in this regard phrase “capital budgeting decision we carefully chosen. Again, consideration will be limited to only select manufacturing company. It will however cover firm directly engaged in converting raw materials of any form to usuable forms.
Sample company shall be drawn from manufacturing concerns in Lagos state.
Capital budgeting decision is a top management function officers at this level may be very busy and unwilling to satisfactory complete and return the questionnaires. Other problems that would likely face during the course of this study area in the area of time. Funds and geographical distance in collecting data and information from sample and chosen manufacturing concern location.
1.8 Definition of the Terms
1. Capital Budgeting:
Is the process of planning evaluating proposals for investment in plant assets.
2. Discount Rate:
Is the required rate of return used by an investors to discount future cash flows to their present value.
3. Present Value:
Is the excess of the present value of there net cash flows expected from an investment over the amount to be invested. NPV is one method of rangking alternative investment opportunities.
4. Payback Period:
Is the length of time necessary to recover the cost of an investment through the cash flows generated by that investment. PSP is one criterion used in making capital budgeting decisions.
5. Present Value:
Is the amount of money today which is consider equivalent to cash in flow or out flow expected to take place in the future. The present value of money is always less then the future amount since money on hand today can be invested to become the equivalent of a larger amount in the future.
6. Relevant Cost:
Is a cost which should be given consideration in making a specific decision.
This is situation in which an event or activity is not likely to happen or occur. This is very vital element in capital investment decision.
8. Long Term Assets:
These are the assets which affects the firm’s operation beyond the one year period.
9. Profitability Index:
The profitability index or benefit/ cost ratio of a project is the present value of future net cash flows over the initial cash outlay. Simply put present value of inflows over the present value of outflows.
10. Discounted Payback Period:
The principles and decision rules are the same as in the normal pay back period method, the only difference, is that the cash flows to be used are discounted at the given or appropriate cost of capital.
11. Mutually Exclusive Project:
These are project that are to be appraisal for acceptance/ rejection solely on each project’s individual merit.
12. Internal Rate of Return:
The internal rate return or yield for investment is the discount rate equates the present value of the expected cash outflows with the present of the expected inflows.
13. Sunk Cost:
That is historical cost, it represents a amount that has already been incurred prior. To the investment under consideration e.g. research and development (where already incurred), preliminary expenses etc. it should be considered irrelevant
This is an accounting derivation and does not involve the physical movement of cash as such should be disregarded.
15. investment Decision:
This involves the identification of viable projects i.e. it deals with appraisal of projects using various techniques to determine those that are viable.
This is defined as the maximum contribution that is forgone but using limited resources for a particular purpose. An alternative way of describing opportunity cost is as the value of a benefit sacrificed in favour of an alternative course of action.
Is a situation in which we do not know exactly the performance of the future uncertain events but we can qualify the possibilities of such future event.
18. Financial Decision:
This involves the identification of the appropriate sources of finance that would be used to finance projects.
19. Divided Decision:
Here attention is focused on the compensation required by the providers of funds i.e. this is the determination required of the appropriate amount to be paid as dividend and the profit that would be ploughed back to finance expansion in the company.
20. History of vitafoam Nigeria Plc.
Vital foam Nigeria plc was incorporated in Nigeria as a private company on 4th August, 1962. The company was established to manufacture foam products having liquid later base such as molded mattresses, cushions pillows and upholstery sheeting.
The first factory was opened at Ikeja in 1963 for the production of latex foam mattresses and cushions. This type of foam was later superseded by the development of polyurethane foam and in 1966.the company installed its fist urethane foam production plant at the Ikeja premises later, the manufacture of carpet unclerlay, fiber pillows, rigid urethane insulating material and vital bond adhesive etc were added to its operations.
The company has acquired a high manufacturing capability through the support in the form of technology, research and development from vital international limited, UK Vita foam manufacturing locations are strategically spread across the country in order to make its range of products easily accessible. Thus, in addition to the Ikeja factory, which has been extensively enlarged, there are now four other manufacturing locations in ABA, JOS, KANO and SAPELE. The company head office is located at the Ikeja factory on Oba-Akran raod Ikeja. The sapele factory is involved with the production of rigid polyurethane foams which are used for insulation purposes in the oil and gas industries cold room construction refrigerated vehicles etc.
1.10 Organization of the Study
This research will be divided into five chapters; each chapter contains the following.
- Chapter one will contain the background of the study, statement of the problem, aim and objective of the study research question, research hypothesis statement significance of the study, scope and limitation of the study. Definition of the terms, history of vital foam Nigeria plc,Lagos.
- Chapter two of the project is the Literature review, which shall look into the basic investment appraised techniques. A review of past studies, the theoretical frame work, capital budgeting, risk and uncertainty, capital investment appraisal under uncertainty and lastly the measure of risk.
- Chapter three of the research work will be the research design determination of sample size, population of the study, sampling method, the data collection method, validation of the instrument, choice of statistical analysis re-statement of research Hypothesis, the questionnaire design and administration, data analysis techniques and lastly the limitation of the research.
- Chapter four of the project will be the presentation analysis of data.
- Chapter five will discuss the summary, conclusion and recommendations of the research work.
5.0 Summary, Conclusion and Recommendations
Capital budgeting decisions are essentially forward looking and the provide a basis for investing in proftable and promising projects.
Capital budgeting decision is a means to an end not an end itself since their estimation projects of future events.
They also serve as realistic estimate of accept performance for project organization.
This research study has focusing the discussion on Capital Budgeting Decision in manufacturing industries using vitafoam Nigeria Plc as a case study. The purpose of this study is to examine the factors influencing capital budgeting decision in manufacturing company, techniques being applied in capital project evaluation, the degree of responsiveness of investment decisions and to provide policy recommendation for future operational effectiveness.
Also, it aim at the determining the significant in capital decision. Based on the literature review as well as the study conducted broadly viewed, the association features of investment evaluation criterion lead to measure the economic worth of an investment projects, which should maximized the share holder of profitability and attractiveness.
In pratical terms, investment techniques are of two categories: discounted cash flow (DCF) and Non-Discounted cash flow. The former fails to recognize the time of money while the later recognize the time value of money.
As it is truly stated in research methodology and research analytical method to the used analyzing the data collected and this method was through out chapter four to analyzed the data collection.
The research question supplies to the respondent by the questionnaire were tested and their responses were received without delay and graded in percentage.
Three hypothesis were tested and accepted in this research study. It is agreed that investment outlay do influence capita budgeting decision.
Hypothesis two also accepted that relevant data acquired do depend on capital budgeting decision while hypothesis three agreed that investment profitability do affect capital budgeting decision.
The data used were collected in the questionnaire and were subject to both percentage analysis and analysis of variance. (ANOVA).
However, certain weaknesses were observed which include:
- Management does not releases decision as at when needed and when the result of the decision will be released it may delay the project at hand.
- Lack of motivation of junior staff by the senior of top management i..e not encouraging them to take activate part in decision making.
- Political and legal frame work, cultural and social values, the economies climate and investors attributes.
- Alternative structure of the firm i.e. This is inadequacy of human resources as one of the most principle factors.
The conclusion for this project was drawn based on the extent to which the findings have been made to answer the research question and how the findings related to the objectives of the studies. The capital budgeting decision used to allocate scarce resources among viable and profitable project.
Since the business organization are very dynamic, rigid method of decision making for business could neither yield satisfactory to provide a universal acceptable result.
Therefore, appropriate decision making process should be followed.
The research shows the importance of the various techniques to capital budgeting decision making, whose flexibility encourage wide range of applicability and reliability.
These various techniques are strongly consider appropriate in terms of profitability, riskness and security on cash flow projection.
After the presentation, interpretation and analysis of the whole data collected through the questionnaire, it in the interest of intelligent of capital budgeting decision and brilliant techniques selection and eventual fruitful evaluation that the following recommendation are proffered.
- For an organization to experience positive change and growth profit maximization should include among its objectives
- Since it becomes necessary to contribute to modern procedures of invest appraisal for organizational growth and development, then corporate manufactures, investors and prospective investors should used modern investment appraisal as a vital tool to bring in the desirous increasing return on third investment.
- The choice of investment should depend on the need for and classification of investment in the organization.
- The interference of emotion and sentiments should be completely avoided in the making of capital investment decision and in the choice of evaluation techniques. Objective here will definitely erase phrases like that is how we do it” that is what we use”
- Lastly, the manufacturing industry is obviously sensitive to the Nigerian economy to be allowed to die. Nigeria government should therefore offer a considerable and encouraging measure that will afford the well thriving and positive development plus long stay of the manufacturing industry in our country.
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