CAPITAL BUDGETING - THE TOOLS FOR PROJECT EVALUATION (original) (raw)
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Capital Budgeting Practices in Islamic Banking: Evidence from Pakistan
The main purpose of this study is to ascertain the amount of current technique in the decision making of a capital budget in the Islamic banking sector, Pakistan, which include real options, and make the result perfect. In Pakistan, a survey of the largest 5 banks and their branches in Faisalabad through email and questionnaires was conducted. Sophisticated techniques tendency have been continued; however, DCF not used by 17% large banks. Among those which did, most of them prefer IRR and NPV. Most of the banks from a selected sample that used DCF were not so effective at it and also ignore real options. Only 8% banks use real options. First limitation is, survey doesn't show why managers are continually using those capital budgeting techniques for decision making, which are less developed. Second research is conducted in Pakistan using a small and convenient sample size of Islamic banks located in Faisalabad. The basic area where management focuses more is a real option. Other improvement areas are administrative procedures using WACC, adjustment of weighted average cost of capital in different projects/divisions, employment of market values or target for weights and excluding interest expenses from the cash flow of the project .The minimum number of managers feels that there is a need that DCF start using. It is clear from the evaluation that theory practice gap still remains in real options, and in the decisions technique of DCF capital budgeting. Moreover, it is precious to capture stock of views that has been improved in many years. What this study suggests is a fine-grained analysis of decisions making on investment, a composition and completion of different papers on DCF where novel illustrations are made, advice was given to managers to improve the opportunities of investment by making good decisions.
This paper presents evidence to identify the most appropriate investment criterion (IRR vs NPV) with emphasis on the controversial multiple, negative and no IRR, mutually exclusive investment and independent projects. The analysis is based on the estimated return of capital (ROC), return on invested capital (ROIC) and capital amortization schedule (CAS). The salient findings are: a. NPV, being a static point estimate, misleads by providing incomplete information at hurdle rate. It fails to indicate the full ROIC that the Net cash flow (NCF) could support. NPV at hurdle rate can at best indicate whether the NCF is fully utilized (NPV = 0) or not fully utilized (positive NPV) or not adequate to cover the cost of capital (negative NPV), respectively. IRR, in contrast, explicitly indicates that the NCF is fully utilized (NPV and the closing balance in CAS are ‘0’) and the ROIC plus ROC are fully recovered. b. In the case of mutually exclusive projects, selecting projects based on NPV at hurdle rate is misleading. A project selected based on higher NPV at hurdle rate ends-up with negative NPV when discounted by the higher IRR achieved by the counterpart project. In the case of counterpart project, the NPV is not negative but zero at that higher IRR as the discount rate. As NPV is a static point estimate (at hurdle rate), this weakness of NPV is not exposed. Among a range of discount rates tried, IRR is the only rate that indicates the full utilization of the NCF (makes the NPV zero) and therefore performs better than the NPV to select or rank mutually exclusive projects. c. Incidences of multiple, negative and no IRR are normally associated with investments with non-normal NCF. For investment with non-normal NCF, the undiscounted cumulative NCF is generally negative or zero even before discounting. Estimating IRR or NPV in such cases will be a mere academic exercise. No smart investor will undertake such an analysis, as the NCF clearly shows that there is negative or zero or negligible net benefit. If an analysis is conducted, the result reveals that the non-normal NCF data affects both IRR and NPV equally, more so NPV. d. The modified IRR (MIRR) is not a solution to the problem of multiple IRR. MIRR keeps increasing without any limits with higher and higher investment rate used irrespective of the fact that the NCF could internally support such a MIRR. These results consistently support the conclusion that IRR is the best criterion to accept or reject or rank mutually exclusive projects as well as independent projects. NPV will still be useful in other areas to estimate the present value. Authors of finance and economic textbooks and other publications may wish to review and consider appropriately update the sections on CBA or capital investment or capital budgeting.
1999
Software firms invest in process improvements in order to benefit from decreased costs andror increased productivity sometime in the future. Such efforts are seldom cheap, and they typically require making a business case in order to obtain funding. We review some of the main techniques from financial theory for evaluating the risk and returns associated with proposed investments and apply them to process improvement programs for software development. We also discuss significant theoretical considerations as well as robustness and correctness issues associated with applying each of the techniques to software development and process improvement activities. Finally we introduce a present value technique that incorporates both risk and return that has many applications to software development activities and is recommended for use in a software process improvement context.
Management Accounting Practices in Sri Lanka: An Empirical Investigation in Banking Sector
Iconic Research and Engineering Journals, 2019
The purpose of this paper is to report the results of an investigation on the use of management accounting techniques among Sri Lankan banking sector.This research findings based on questionnaire survey done among 30 banks in Sri Lanka. The analysis revealed that there is an enthusiasm among managers in implementing management accounting techniques in their organizations decision making process. According to the respondents response most of firms widely used net present value and internal rate of return techniques for decision making process. However, deeper analysis of data revealed that there is a lack of utilization of accounting rate of return, payback period and profitability index techniques among the managers. The findings of the paper will provide information to the practitioners to utilize management accounting techniques in their organizations and to academics to design courses for management accounting to enhance quality of management decision making process. It is important to implement the related techniques in full to realize the benefits of management accounting techniques. This paper reveals the level of use of these techniques by the banking sector managers in Sri Lanka.
Capital Budgeting Practices of the Fortune 1000: How Have Things Changed
Capital budgeting is one of the most important decisions that face the financial manager. Prior studies spanning the past four decades show financial managers prefer methods such as internal rate of return or non-discounted payback models over net present value; the model academics consider superior. This interesting anomaly has long been a puzzle to the academic community. A recent survey of the Fortune 1000 Chief Financial Officers finds net present value to be the most preferred tool over internal rate of return and all other capital budgeting tools. While most financial managers utilize multiple tools in the capital budgeting process, these results better reflect the alignment of the academic and business view.
Capital Budgeting and Cost Evaluation Techniques: A Conceptual Analysis
International Journal of Science & Research , 2018
Capital budgeting decisions are crucial to a firm's success for several reasons. Firstly, capital expenditures typically require large outlays of funds. Secondly, firms must ascertain the best way to raise and repay these funds. Thirdly, most capital budgeting decisions require a long-term commitment. Finally, the timing of capital budgeting decisions is important. When large amounts of funds are raised, firms must pay close attention to the financial markets because the cost of capital is directly related to the current interest rate or investor?s expected rate of return. This Published paper focuses on advances in Capital Budgeting Techniques theory through and practical. Also its impact in the decisions of the investment while focusing on evaluation practices such as risk and uncertainty but not considering the numerically appraising of the principles of investment. The sensitivity analysis of capital budgeting depends on a number of uncertain independent variables which may have some impacted on the investment results. The positive value of the investment appraisal is value added to the firm, and it can be enhanced return for the shareholders. The success of the project is assessed on stage post completion audit with proper stage by stage completed.
SELECTED CAPITAL INVESTMENT PRACTICES IN A SOUTH AFRICAN PETROCHEMICAL COMPANY
SUMMARY Investment in productive fixed capital assets is a prerequisite for economic growth in companies and countries alike. Due to increasing uncertainty in the macro environment and the financial phenomenon of differential escalation in individual cost or revenue elements of the business where exports or imports are concerned, two aspects of the financial evaluation of proposed fixed capital investments have become crucially important. These are the following: The evaluation, over time, of the effect of differential escalation rates on the projected cash flow of the proposed investment. The evaluation of the total risk associated with the project. The traditional financial methods for the evaluation and quantification of risk are subject to many technical complications, and fail to analyze the nature of the risks involved, and expressing these in the form of an easily understandable algorithm. In this work, the traditional financial approaches are adapted in order to address the two problem areas indicated. It is shown that the effect of differential escalation rates is most easily accounted for by discounting nominal (as opposed to real) cash flows at the applicable risk free nominal rate of return, after escalating individual cost or revenue elements at the individually applicable rates. The result is regarded as a base case, and an optimistic return for the project, which is used in the quantification of the possible effect of the total risk of the project. It is shown in this work that the effect of risk is best evaluated outside of the discounting process. Utility theory, adapted to the probability equivalency rather than the certainty equivalency approach, provides an excellent vehicle to accomplish this. A model is proposed for the subjective evaluation of the total project risk, and the risk adjustment factors derived from this model are used in calculating the probable financial return from the project. In addition, a simple graphical presentation of the total risk is suggested, which makes it possible for the decision maker(s) to analyze the total project risk at a glance. It is emphasized, however, that these results are but one factor in a comprehensive decision process, and must be considered together with other factors such as strategic considerations and the wider iii economic impact of the proposed project. The subjective evaluation of risk, as well as organisational decision processes, are subject to a number of influences. These may be classified into three types, namely cognitive effects, group effects, and organisational effects. It is shown that the human mind is a notoriously poor instrument for analyzing and quantifying risk. Similarly, group and organisational effects can have a very adverse impact on the evaluation of risk. The nature of these complications is discussed. It is proposed that knowledge of these aspects should be built into the risk evaluation and decision processes, in order to minimise their adverse effects. It is believed that this can be achieved in the model which is proposed.
CAPITAL BUDGETING PRACTICES OF MALAYSIAN COMPANIES
This study presents the capital budgeting practices of Malaysian companies through 4 stages: Identification, Development, Selection and Control. It is based on a questionnaire sent to 240 Malaysian companies of various industries and sizes, which received a response rate of 15%. The main purpose of the study is to examine the capital budgeting practices of Malaysian companies and to identify possible gaps between theory and practice. The study shows that Malaysian companies have a structured investment appraisal process to support long term objectives and are progressively moving towards sophisticated capital budgeting practices such as the use of Discounted Cash Flow method, probabilistic type of risk assessment tools, and Real Options. However, a theory-practice gap remains. Payback method is still the most frequent tool used by Malaysian companies to evaluate potential investments. Among the Discounted Cash Flow method, Internal Rate of Return is preferred over the theoretical superior Net Present Value. The study also aims to investigate the determinants of sophisticated capital budgeting practices. In the context of this study, sophistication is assessed in totality with respect to capital budgeting process. Three sophistication indexes are constructed to regress on company characteristics using a robust ordered probit model. Results indicate that the type of industry that a company operates in and its management structure are related to the sophistication of capital budgeting practices. A significant higher level of sophistication is found for companies in the service industry and those that appoint non-owners executives to manage the company. Similar with other empirical research, this study has its limitations, such as the sampling method, sample size, and response bias. A wider set of data and determinants including top management characteristics could have perhaps enhance the findings of this study. Nevertheless, the findings of this study can be utilized to encourage better capital budgeting practices and to improve overall decision making of Malaysian companies.
This study examines the type of capital budgeting methods used by textile firms in Pakistan and impact of firm size on these methods. This study also investigates the relationship between the total assets of the firm and annual turnover of the firm according to primary capital budgeting technique used. Questionnaire method is used as a source of gathering primary data. SPSS is used as tool for analysis of data. Cross tabulation is applied on each variable. Chi square test is also applied to investigate the relationship between total assets of firm and total turnover of the firm according to primary capital budgeting technique used. Findings of this study reveal that net present value method and internal rate of return are two mostly used methods. Findings also show that there is no relationship between the total assets of the firms and turnover of the firm according to capital budgeting technique used by firms. These results are well supported by the literature.