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
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
and the general public will benefit immensely from the
outcome of this study.
4. The study will be of immense benefit to emerging
entrepreneurs, students and researchers in capital budgeting
and risk.
5. It will serve as reference point for future study and research
in the area of capital budgeting decision.
6. It is hoped that the result of the study will stimulate more
extensive and exhaustive study on the subject matter in
Nigeria’s context.