Capital Budgeting in Corporate Sector A Case Study

M. Kannadhasan1 - Dr. R. Nandagopal2

Abstract
In todays ever changing world, the only thing that does not change is change itself. Change can trigger any corporate growth which can be measured in terms of increase in investments or sales. A progressive business firm continually needs to expand its fixed assets and other resources to be competitive in the race. Investment in fixed assets is an important indicator of corporate growth. The success of the corporate growth in the long run depends upon the effectiveness with which the management makes capital expenditure decisions. In the dynamic business environment, making capital budgeting decisions are among the most important and multifaceted of all management decisions as it represents major commitments of companys resources and have serious consequences on the profitability and financial stability. How far the corporate attains financial stability and profitability over a period of time, while making capital budgeting needs evaluation and is a million dollar issue. In view of this, this study has made an attempt to analyse the efficiency of the corporate sectors capital budgeting through their financial statements.

Introduction
In todays ever changing world, the only thing that does not change is change itself. Successful companies are always looking at ways in which they can change and develop. Change can trigger corporate gro wth and Grow th i s essential for sustaining the viability, dynamism and value enhancing capability of a company, which lead to higher profits and better the shareholders value. To achieve the desired growth, the firm has to be competitive in all functional areas especially in financial management which is the back bone of any business. Primarily gro wth can be measure d in terms investments or sales. o f ch ange in

A prog ressive business fi rm continually needs to expand its fixed assets and other resources to be competitive in the race. Investment in fixed assets is an important indicator of corporate growth. The success of the corporate in the long run depends upon the effectiveness with which the management makes capital expendi ture decisio ns. The finance manager should ensure that he has explored and identified potentially lucrative investment opportunities and proposals and se lect the best on e based on the opportunities identified.

1. Faculty Member, Bharathidasan Institute of Management (BIM), Trichy, kannadhasan_m@bim.edu 2. Director, PSG Institute of Management, Coimbatore, e-mail: director@psgim.ac.in

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In the dynamic business environ ment, making capital budgeting decisions are among the most important and multifaceted of all management decisions as it represents major commitments of companys resources and have serious consequences on the profitability and financial stability. Evaluation need to be done for the extent of financial stability achieved by the firms capital budgeting decisions over a period of time. In view of this, this study has made an attempt to know the efficiency of the corporate sectors capital budgeting decisions.

its future performance. In view of this, this research provides comprehensive analysis of the efficiency of the corporate sectors capital budgeting decisions which got reflected in their financial statements.

Review of Literature
Over the years, Research on Capital budgeting is well documented in many countries. Some examples of these are in USA (Kl amme r, 1972, Gitman and Forrester, 1977, Cooper et. Al, 1990, Graham and Harvey 2001& 02, Ryan & Ryan, 2002 Stanley Block, 2005), the UK (Jog & Srivastava, 1995), Asia-Pacific Region (Wong, Farragher, and Leung, 1987, Kester & Chong, 1998, Kester et.al, 1999,) China & Dutch (Niels Hermes et. Al, 2005,), South Africa (Hall, 2000,), Cyprus (Lazariids , 2004), and India (Prasanna Chandra, 1975, Porwal, 1976, Pandey, 1989, Rao Cherukuri, 1996, Manoj Anand, 2002, Sarkar 2004, Lokanandha Reddy Irala, 2006, Tamilmani, 2004 & 2007). The research studies so far are mostly concerned with the capital budgeting practices in corporate sector with specific focus on appraisal methods, income measurement, determination of discount rate and risk analysis. Almost all the studies used primary data as the basis and the analysis was sketchy. Though there have been many studies published in journals relating to capital budgeting decision in the corporate world, but no study has been specifically done on capital budgeting based on secondary data which could be dealt in this study.

Rationale of The Study

The success of any business depends on the adjustments and adaptations it makes in its operations to match the external competitive environment. Swift reactio n to the changin g bu sine ss environment is ensured only when the organization is effective in decisionmaking in all its operational areas. This is a good sign for the growth-oriented companies. Growth oriented companies need to invest sizable proportion of its capital in the fixed assets constantly. Rate of investments in the corporate sector depends on the internal growth decisions rel atin g to various decisio ns viz. replacement, expansion, modernization, introduction of new product lines and also capability of raising resources for financing growth. Thus, Capital budgeting decision is a major corporate decision because it typically affects the firms business performance for a long period of time. While making capital budgeting decisions, the company needs to foresee the impact on

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Journal of Contemporary Research in Management, January - March 2008

Scope of The Study

This study is confined to one limited company with eight years study period from 1998-99 to 2005-06 with special reference to commercial vehicle industry. The study is based on financial data obtained from the published annual reports. The technique used for the analysis is historical funds flow analysis which has also its own limitations.

Objectives of The Study

This study has the following objectives: 1. To know the fixed investment and financing trend of the company To assess the growth rate in the fixed investment pattern of the company To trace out the influencing factors on fixed investment and financing trend of the company

company from 1998-99 to 2005-06 through their website and this study was also used the directors reports pertaining to fixed investment decisions made during the study period. The data collected are an alysed w ith the hel p of differe nt accounting and statistical tools. The analysed data are presented in the form of funds flow statement, fixed investment analysis statement, fixed investment growth statement, and statement of correlation.

Results & Discussions

The sample company is the leader of the commercial vehicle industry over the past five decades. As regards to its size, the company belongs to the large size category with a net tangible fixed assets valuing is 10599.75 million (2005-06). The subscribed capital of the co mpan y re main ed unchanged till 2004-05, at Rs. 1189 millions and with a Rs. 33 million increase in 2005-06. But investments in fixed assets have undergone several changes during this period. The manner in which the fixed investments have changed and the sources of financing are discussed in this part. 1. Fixed investment Analysis Statement: During the study period, the purpose of investments of this company is for capacity expansion/up-gradation and R&D. We observe that out of 8 years, investments have been financed by internal sources for 5 years. Besides the internal sources, this company have also raised funds from external sources to finance their additional fixed investments during 1998-99, 200019

2.

3.

Hypotheses of The Study

Having identified the objectives of this study, the following hypotheses have been formulated and tested during the period of stu dy: 1. Corre latio n be twee n fi xed investments and the selected internal factors (sales, profits, depreciation) is not si gnifican t. 2. Co rre lati on betwe en internal factors (sales, profits, depreciation) of this company is not significant

Research Methodology
The research design of this study is descriptive in nature. This study is based on secondary data which was obtained from financial statements published by this

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01, and 2004-05. The second major source of finance is long-term debts from term lending institution and banks. 2. Trends in Fixed Investment: In order to discover the fixed investment trend of this company, the rate of increase in fixed assets during the year has been computed. In the process of classification, these rates are classified into two categories by taking normal busi ness practices i nto

consideration and the findings of empirical analysis. A.Regular/routine Investments: Company invests less than 15 per cent of investments as regular/routine invest ments for maintenance and replacements and B.Growth / expansion oriented Investments: Company invests more than 15 percent consider as grow th and expansion.

Table 1 Fixed Investment Classification Statements (Figures in Millions) Financial Year Net Fixed Assets at the beginning of the year 8935.22 9150.34 8915.41 9560.99 9025.19 8748.29 8938.46 9432.71 Fixed Assets increased during the year 1665.49 1076.98 1050.12 1613.16 1326.53 792.08 1796.95 2426.32 Percent of Increase Classification

1998-99 1999-00 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06

18.64 11.77 11.78 16.87 15.00 09.05 20.10 25.72

G R R G G R G G

As we can see form the table 2, the annual rate of growth in fixed statements and their classification. In the year 199900, 2000-01 and 2003-04, the investments represents routine investments category for normal maintenance and replacements whereas the rest of the years reliable to growth and expansion. The amo unt of i ncre mental investments increased its height in 2005-

06 with Rs. 2426.32 millions. The highest rate of growth is found in the same year with 25.72 per cent. Overall trend of fixed investments during the study period is found to be increasing with an annual average investment of Rs. 1468.45 millions and standard deviations of Rs. 519.76. However there are deviations for some years. Accountable Factors for Fix ed Investment: The purpose of Investments

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differs one to another firm. For example, the purpose of expansion is to meet the growing demand for products; the purpose of modernisation helps to reduce the cost through new production processes; and diversification helps to additions to existing product line. All these forms help to increase the sales, in turn to increase profits of the companies in the long run. In this study, we have tried to correlate each internal factors such as sales, profit and depreciation charges with fixed investments.

production, and promotion programmes provides the demand for the product goes up in the market. This has been proved by this company as it occupies the good position in the market. From the analysis, it is clear that the fixed investments and sales have the close and direct relationship between each other.

b. Fixed investments and profit: As we mentioned above, increase in fixed investment is to enhance the earning capacity of the company. It is clear from the table 3 where we can find a shift from loss into profit. There are number of a. Fixed Investments and sales: fluctuations with substantially high and Trends of fixed investments and the sales low levels of the fixed investments and show the same trend but the per cent of profits during the study period. The changes are vary during the study period. coefficient of correlation between profits The coefficient of correlation between sales and fixed investments is found to be 0.43 and fixed investments is found to be 0.60 (see table 3) which is statistical ly (see table 3) which is statistical ly sig nifi cant at 5 pe r ce nt l evel of sig nifi cant at 5 pe r ce nt l evel of significance, indicating poor association sig nifi cance, sugge stin g th at the between the variables. This is mainly due relationship between the variables is to ine fficient uti lisatio n of fix ed moderate. Capital budgeting decisions may investments. Hence the management has increase the sales through increased to improve its utilisation of fixed assets. Table 2 Statement of Descriptive Statistics & Selected variables Financial Year 1998-99 1999-00 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 Mean SD CV Incremental Fixed Investments 1665.49 1076.98 1050.12 1613.16 1326.53 792.08 1796.95 2426.32 1468.45 519.76 282.52 Sales 20450.71 25987.18 26066.63 26304.48 30739.95 39272.73 48112.82 60531.08 34683.20 13668.07 253.75 Profit -120.62 805.86 913.77 1172.31 1634.78 2773.59 3108.38 3976.11 1783.02 1377.19 129.47 (Figures in Millions) Depreciation 690.40 641.42 784.41 765.02 1752.18 912.63 1075.91 868.24 936.28 356.61 262.55

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c. Fixed investments and depreciation charges: This is another important internal factor considered to be associated with fixed investments. In our study, we found that very poor relationship between the variables (-0.01) and this coefficient is statistically insignificant at 5 per cent level of significance.

Normally, more the investments in fix ed assets, th e hi gher will be the depreciation charges which help the company for additional investments in fixed assets. An appropriate method of depreciation on fixed assets not only helps the company to retain the profits and also for a proper tax planning. But this companys utilisation is very poor.

Table 3 Simple Correlation Analysis Variables Between FI & Sales FI & Profits FI & Depreciation Sales & Profits Sales & Depreciation Profits & Depreciation Correlation (r) t Value for r Table Value @ 5 per cent level 4.5 2.86 -0.06 1.895 1.895 1.895 D.F Results

0.60 0.43 -0.01

6 6 6

Ho Rejected Ho Rejected Ho Accepted

0.97

23.94

1.895

Ho Rejected

0.16

0.97

1.895

Ho Accepted

0.26

1.62

1.895

Ho Accepted

d. Sales, profits and depreciation ch arges: We have anal yse d the rel atio nshi p be twee n th e variables themselves, we observe a difference picture. The coefficient of correlation between sales and profits is found to be 0.97 which shows a high degree of positive rel atio nshi p. The same has tested statistically, and the result is insignificant

at 5 per cent level of significance. The degree of correlation between the sales and depreciation (0.16) and between the profits and deprecation (0.26) show the low degree of positive correlation which is significant at 5 per cent level.

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Conclusions
The incremental investments in fixed investments show an increasing trend during the study period with an average of Rs. 1468.45 mil lion s an d standard deviations of Rs. 519.76. However the investments are not uniform through out the study period. In this study, we found that the coefficient of correlation between incremental fixed assets and sales to be positive and significant. Similarly, the coefficient of correlation between fixed investments and profit have the moderate relationship and statistically significant. However, the relationship between the fixed investments and depreciation have the poor relationship and statistically insignificant. As regards, the sources of funds towards the fixed investments for this company are internal sources. In order to maintain the market position with its products, every company must produce product as good as, or better than its competitors. This leads to fixed investments decisions which can be classified into two: routine and expansion. Every company has to make routine investments continuously whereas growth investments are made intermittently. The basic challenging task of fixed investment decisions lies in the search for lucrative opportunities and to derive the benefits in the uncertainty environment in quantitative terms. From the empirical analysis, this companys fixed investments decisions are wise and shows better fund management

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