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.

1.5            REASEARCH HYPOTHESIS

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