...CHAPTER ONE Introduction Understanding and being able to use capital budgeting techniques and investment appraisal tools is usually a standard requirement for most business degrees. In addition learning such methods will also give one an advantage in a real business situation, in which there is the consideration of significant capital expenditure project. Capital budgeting assists management decisions making on the process of ensuring growth of the organization. The techniques are divided into two types: one, Traditional (non-discounting) that includes pay back method, accounting rate of return (ARR). Two, discounting cash flow that includes net present value (NPV), internal rate of return (IRR) Profitability Index (PI). Before an investment appraisal is conducted, there are a number of points to keep in mind. Whilst the tool presented will give an evaluation of the worth of a project, one should consider that the answer is only a guide. In short, the results of an investment appraisal should be considered in conjunction with both common sense and other qualitative factors such as a business’s overall strategy. Secondly, before an investment appraisal is conducted, one should consider whether or not the project is mutually exclusive. Where a project is mutually exclusive, then only the best project should be selected. Where on the other hand, projects are independent; one may select all projects which give the appropriate return. 1.1 Background of the study Corporate finance...
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...CAPITAL BUDGETING: ADVANTAGES AND LIMITATIONS. SEPTEMBER 2012 CHAPTER ONE INTRODUCTION 1.0 Background Study Capital budgeting is the process by which firms determine how to invest their capital. Included in this process are the decisions to invest in new projects, reassess the amount of capital already invested in existing projects, allocate and ration capital across divisions, and acquire other firms. In essence, the capital budgeting process defines the set and size of a firm’s real assets, which in turn generate the cash flows that ultimately determine its profitability, value and viability. In principle, a firm’s decision to invest in a new project should be made according to whether the project increases the wealth of the firm’s shareholders. For example, the Net Present Value (NPV) rule specifies an objective process by which firms can assess the value that new capital investments are expected to create. As Graham and Harvey (2001) document this rule has steadily gained in popularity since Dean (1951) formally introduced it, but its widespread use has not eliminated the human element in capital budgeting. Because the estimation of a project’s future cash flows and the rate at which they should be discounted is still a relatively subjective process, the behavioural traits of managers still affect this process. Capital budgeting is a process...
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...‘When calculating variances, we in effect ignore differences of volume of output, between original budget and actual, by flexing the budget. If there were a volume difference, it is water under the bridge by the time that the variances come to be calculated’. Variance analysis typically involves the isolation of different causes for the variation in income and expenses over a given period from the budgeted standards. So for example, if direct wages had been budgeted to cost $100,000 actually cost $200,000 during a period, variance analysis shall aim to identify how much of the increase in direct wages is attributable to: * Increase in the wage rate (adverse labour rate variance); * Decline in the productivity of workforce (adverse labour efficiency variance); * Unanticipated idle time (labour idle time variance); * More wages incurred due to higher production than the budget (favourable sales volume variance). Variance analysis highlights the causes of the variation in income and expenses during a period compared to the budget. In order to make variances meaningful, the concept of 'flexed budget' is used when calculating variances. Flexed budget acts as a bridge between the original budget (fixed budget) and the actual results. Flexed budget is prepared in retrospect based on the actual output. Sales volume variance accounts for the difference between budgeted profit and the profit under a flexed budget. All remaining variances are calculated as the difference...
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...Management Blekinge Institute of Technology THE IMPORTANCE OF THE PAYBACK METHOD IN CAPITAL BUDGETING DECISION. By Alaba Femi, AWOMEWE & Oludele Olawale, OGUNDELE Supervisor: Anders Hederstierna Thesis for the Master’s degree in Business Administration Fall/Spring 2008 THE IMPORTANCE OF THE PAYBACK METHOD IN CAPITAL BUDGETING DECISION. By Alaba Femi, AWOMEWE & Oludele Olawale, OGUNDELE A thesis submitted in partial fulfillment of the requirements for the degree of MBA (Master of Business Administration) Blekinge Institute of Technology 2008 Supervisor Anders Hederstierna ii Abstract Title: The importance of the Payback method in Capital budgeting decision. Authors: Alaba Femi, Awomewe and Oludele Olawale, Ogundele Supervisor: Anders Hederstierna Department: School of Management, Blekinge Institute of Technology Course: Master’s thesis in business administration, 15 credits (ECTS). Background and Problem Discussion: The capital budgeting decision has been a very typical issue in the sustenance of a company. Several companies have lost their identity or liquidated due to wrong capital budgeting decision they made at one particular time or the other. Based on these prevalent problems in industries and the effect of globalisation on industries, it is important to use effective method to analyse investment before decision is made. Capital budgeting is extremely important because the decision made involve the direction and opportunity...
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...be taken when selecting from a range of projects is which method(s) of Capital Budgeting a company will opt for in order to arrive at the final proposed solution. “Investment decisions must be consistent with the objectives of the particular business. For a private sector business, maximising the wealth of the owners (shareholders) is usually assumed to be the key financial objective.” (Atrill and McLaney, 2009, p. 259) As a company exists primarily to increase the wealth of the stakeholders it should only invest capital to implement a project when the outcome will result in benefits that exceed the cost of the investment. Appraisals need to be carried out in order to select the project which provides the best return on that investment. Capital Budgeting is the process of appraising these projects in order to select the project most suited to the company‟s strategy. The purpose of this report is to discuss four methods of appraisal (Payback Period, Accounting Rate of Return, Net Present Value and Internal Rate of Return). A case study describes each of these appraisal processes when applied to the requirement to purchase one printing press, to be selected from two qualifying contenders. This is achieved through an in-depth appraisal analysis coupled with a review of sensitivity analysis, in turn followed by an assessment of installation risks that could adversely affect the appraisal process. “Budgeting and cost management is the estimating of costs and the setting of an agreed...
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...Managing Financial Principles and Techniques - Financial and Investment analysis Contents 1. Be able to apply cost concepts to the decision-making process 2 2. Be able to apply forecasting techniques to obtain information for decision making 4 3. Be able to participate in the budgetary process of an organization 5 4. Be able to recommend cost reduction and management processes for an organization 7 5. Be able to use financial appraisal techniques to make strategic investment decisions for an organization 8 6. Be able to interpret financial statements for planning and decision making 10 References 12 1. Be able to apply cost concepts to the decision-making process 1.1 explain the importance of costs in the pricing strategy of an organisation The pricing strategy becomes the major element in marketing mix of Dell Computers as it is related to product positioning. When there is a planning for new product launch pricing strategy is important and it requires general sequence of stages involved during pricing the new product. The different steps are as follows: (Daft, 2011) * Developing marketing strategy – helps the company to develop marketing strategy based on market analysis, market segmentation and positioning * Marketing Mix decisions – Defining a product, distribution and its promotional tactics * Estimation of demand curve – Estimating the demand and understand how it varies from quantity wit price * Cost Calculation – Calculation of fixed...
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...The misapplication of capital investment appraisal techniques Colin Drury Professor, University of Huddersfield, Huddersfield, UK Mike Tayles Lecturer, University of Bradford, Bradford, UK Surveys of capital budgeting practices in the UK and USA reveal a trend towards the increased use of more sophisticated investment appraisals requiring the application of discounted cash flow (DCF) techniques. Several writers, however, have claimed that companies are underinvesting because they misapply or misinterpret DCF techniques. Such claims have been made on the basis of observations in only a few companies, or anecdotal evidence, without any supporting statistical evidence. Reports on a recent survey conducted by the authors which suggests that many UK firms are guilty of misapplying DCF techniques. Also provides evidence relating to some issues that have not been thoroughly examined in previous studies, namely the impact of company size and the relative importance that firms attach to different investment appraisal techniques. An examination of the surveys of capital budgeting practices that have been undertaken during the past 20 years in both the UK and USA reveals a trend towards a continuing increase in the use of more sophisticated capital budgeting techniques. In a longitudinal survey of capital budgeting practices of large UK companies between 1975 and 1992 Pike (1996) reported a substantial increase in the usage of discounted cash flow (DCF) and risk appraisal techniques. In 1975...
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...SRJIS/BIMONTHLY/ALBANUS MUNYAO (718-729) THE RELATIONSHIP BETWEEN CAPITAL BUDGETING TECHNIQUES AND FINANCIAL PERFORMANCE OF COMPANIES LISTED AT THE NAIROBI STOCK EXCHANGE, KENYA Albanus Munyao, South Eastern Kenya University P. O. Box 170-90200, Kitui-Kenya Fredrick Mukoma Kalui, Egerton University, P. O. Box 536, Njoro-Kenya Jacqueline Ngeta, South Eastern Kenya University P. O. Box 170-90200, Kitui-Kenya Abstract The general objective of the study was to find out the relationship between capital budgeting techniques and financial performance of companies listed in the Nairobi Stock Exchange. The specific objectives of the study were to determine the Capital budgeting techniques used in investment appraisal decisions amongst Companies listed at the Nairobi Stock Exchange. The study also aimed at establishing the relationship between Capital budgeting techniques and the financial performance of companies listed at the Nairobi Stock Exchange. The study employed a survey design to determine the capital budgeting techniques and their relationship with financial performance in companies quoted at the NSE. Primary data was collected through questionnaires which were dropped and picked from the respondents. Secondary data was collected from the published accounts of the companies. The target population consisted of all the 47 companies listed at The Nairobi Stock Exchange as at 30th June 2010. The choice of quoted companies was preferred because they represented...
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...theoretical concepts and frameworks to a range of practical situations in order to propose solutions to business problems. This assignment consists of THREE (3) parts. The purpose of this assignment is to help the students to understand how an organization demonstrates key areas of financial management in practice. The students will also learn to identify the corporate goals that are important to an organization and therefore, be the main objective of financial managers. Besides, students will also be familiarizing with the financial market especially capital market. Students will have a better understanding on importance of efficient market hypothesis to financial management and ability to explain the difference between the various forms of market efficiency. Lastly, students will identify and distinguish the differences between security valuation and capital budgeting together with the importance of capital budgeting to an organization. Project Outline: Part 1 * Each student is required to choose 2 listed companies that operate in different sectors of the economy. The companies should be quoted on either the London Stock Exchange or Bursa Malaysia. * Examine the annual report for the 2 companies, and briefly describe the background of the 2 companies. * Examine the chairman’s statement from the latest annual report. Are the corporate goals clearly specified? What specific references are made to financial management? Part 2...
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...Capital Budgeting: Capital budgeting is the process of determining whether or not an investment is worthwhile. Often companies will have several opportunities and must measure each one's potential in order to make a comparison and choose just one or a few. It 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 benchmark. 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. On the other hand capital budgeting is the planning process used to determine whether an organization's long term investments such as new machinery, replacement machinery, new plants, new products, and research development projects are worth the funding of cash through the firm's capitalization structure (debt, equity or retained earnings). It is the process of allocating resources for major capital, or investment, expenditures. One of the primary goals of capital budgeting investments is to increase the value of the firm to the shareholders. Capital budgeting involves allocating...
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...formulated according to the American Accounting Association. It defines accounting as a process of providing both financial and non-financial to decision makers. The varying nature of business characteristics implies that also techniques used in managerial accounting for each business differ as the business grows. During start up the business rely on capital investment and budgeting techniques. A mature business relies upon quality control and cost management. Techniques used ultimately assist the business to achieve its long-term and short-term aims via efficient decision-making. The objective of this paper is to study each concept available in the accounting definition and provide a framework needed for deep understanding of aspects and issues involved in the process of accounting. The paper will have two part. The first part will look at the first aspect that is to define managerial accounting and look at its role, techniques and ethical issues facing managerial accountant. We will also highlight the role of a managerial accountant. In the second part, three topics will be covered. The three topics are; cost investment techniques, budgeting, and quality control. In the selected topics, real-world cases will be presented in relation to how they relate to managerial accounting techniques. Managerial accounting is defined as process involving preparation of management accounts and reports so as to provide timely and accurate statistical data needed by managers in their routine decisions...
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...Capital budgeting is a process that involves making of investment decision by company from one or a series of investment projects to identify the most worthwhile projects for undertaking. A company’s capital investment usually focuses:- • Expansion in existing market • Develop new products or entering new market • Purchase new building / plants • Replacement or improvement on existing equipment Capital budgeting decision is vital for any company because it always involved: • Large investment – capital budgeting decision usually involve large investment of funds but mostly there is a shortage of funds at every firm. Hence the funds and the resources need to be controlled by the firm • Irreversible nature- once the decision for acquiring a permanent assets is taken, it becomes very difficult to dispose of these assets with the incurring heavy cost • Long term effect on profitability- Not only the present earning of the firm is affected but the future growth and profitability also depend upon investment decision taken today, any unsound decision made can lead to a downfall tomorrow Capital budgeting is a complex process as it involved decision relating to the investment of current funds for the benefit to be achieved in the future but future is always uncertain. The 5 step process in capital budgeting decision is: I. Identified investment opportunities- investment proposal or projects normally was initiated by a firm’s management or staffs in line with the corporate...
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...size builder segment 7. A Study on Investors Preference towards equity broking. 8. A study on Consumer buying behavior on FMCG 9. A study on Absenteeism among the employees 10. A study on Training Effectiveness in the organization 11. A study on Credit Appraisal for Car loan financing in the finance companies. 12. A study on Consumer buying behavior towards two wheeler bikes. 13. A study on Effectiveness of Performance Management system among the employees 14. A study on Effectiveness of Quality Initiativeness among the employees. 15. A study on Safety , Welfare and Health among the employees. 16. A study on Training and Recreation programmes among the employees. 17. A study on the investor behavior towards the mutual funds investments. 18. A study on Induction Training Program among the employees. 19. A study on Quality of Work Life among the employees. 20. A study on potentiality of Auto and Engineering companies. 21. A study on Customer Financial Need Analysis. 22. A study on financial position of the firm and a comparison of cash management product and multicity cheque facility 23. A study on Effectiveness of performance of Management System among the employees. 24. A Study on Working Capital Requirements of the Comapnay. 25. A study on Finanacial Performance of the Company. 26. A review on financial performance of the company 27....
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...1 HOTEL OWNER / OPERATOR STRUCTURES: IMPLICATIONS FOR CAPITAL BUDGETING PROCESS Chris GUILDING Service Industry Research Centre, and School of Accounting and Finance Griffith University – Gold Coast Campus Queensland AUSTRALIA C.Guilding@griffith.edu.au Tel: (07) 5552 8790 Fax: (07) 5552 8068 I am grateful for funding support for this study provided by the Australian Cooperative Research Centre for Sustainable Tourism. I would also like to acknowledge the helpful comments and suggestions provided by two anonymous referees. 23 HOTEL OWNER / OPERATOR STRUCTURES: IMPLICATIONS FOR CAPITAL BUDGETING PROCESS ABSTRACT The findings of a field study concerned with appraising capital budgeting process implications arising from different owner / operator structures employed in the hotel industry are reported. Dimensions of conflict that can arise between hotel operators and owners are examined. Consistent with expectations motivated by agency theory, data collected suggest that capital budgeting systems in hotels operating under a divorced owner / operator structure exhibit more formalisation and a greater propensity for investment proposal cash forecast biasing. These findings suggest a degree of dysfunctionalism associated with the divorced / owner operator structure widely adopted in the hotel industry. Key words: Hotel, Capital Budgeting, Ownership structure, Agency theory.4 ...
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...Part A: BUDGETING PROCESS 1. Definition [1] * A budget is the financial blueprint or action plan for an organization. It translates strategic plans into measurable expenditures and anticipated returns over a certain period of time * Budgeting is the process of creating and preparing an organization for the future. 2. Objectives[2] * The budget provides a yardstick for future results can be compared; * It allows management to plan and forecast in the areas of capital adequacy in work and or other types of scarce resources available; * Budget may direct cost of capital towards the most beneficial; * Budget support planning and control income and expenditure for maximum profit can be achieved; * It acts as a guide for management decisions when unforeseen conditions affect the budget; * It support for decentralization of responsibilities for each of the managers involved. With the establishment of the budget, the relevant managers will better understand what the company expected from them. So there is a congruence of objectives between the company and employees. 3. Classification of budgets [3] A series of budgets are linked together in a Master Budget. The major parts of Master Budget are Income Statement budgets and Balance Sheets budgets as follow: 4.1 Income statement budgets: * Sales budget: indicates for each product the quantity of estimated sales and (2) the expected unit selling price * Production budget: ...
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