Beruflich Dokumente
Kultur Dokumente
A Report
On
Capital Budgeting
Practices in Bangladesh
[Course Title: Financial Management]
[Course Code: FIN2122; Section: 4]
SUBMITTED TO:
Lecturer
School of Business Studies
Southeast University
SUBMITTED BY:
IMPACT GROUP
Md. Akib Javed Khan (GL)
2015110000272
Rakib Hasan
2014210000058
2015010000021
2012010000077
2012010000062
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Table of Contents
Topic
Name
Page
Range
Particulars
Title Page
Cover Page
Group List
Letter of Transmital
Acknowledgement
Executive Summary
1
2
3
5
6
7
8
8
9
9
Chapter 2 (Methodology)
2.1 Data Collection
2.2 Data Processing
2.3 Data Presentation
10
11
11
Conclusion
References
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11
11
13
14
14
15
16
17
17
17
18
19
Letter of Transmittal
Date: 17th December, 2016.
Dear Sir,
Attached please find the report entitled A Report on Capital Budgeting Practices in
Bangladesh. This report explains in detail about the capital budgeting, techniques of capital
budgeting, the reasons of using capital budgeting, which organizations use capital budgeting
in Bangladesh etc. This report is made and submitted by us, the Impact Group as Southeast
University students in BBA and for the assignment of the course Financial Management.
We would much appreciate if you read our report carefully and allure our internal ability, so
that we can be the perfect for completing the other reports in future and hereby.
If you have any questions or comments about this report, please notice us affluently and
continuously to make it better. It will be a great pleasure for us.
Sincerely yours
_______________________
Md. Akib Javed Khan
(On behalf of the whole study group)
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DECLARATION
I, the undersigned, Md. Akib Javed Khan, on behalf of the Impact Group, declare that this
plan is entirely our own written (MS Word) work, except where otherwise accredited, and
that it has not been submitted for any other competition, award purpose or assignment to any
other university or any other courses of the university.
____________________
Sincerely yours:
Md. Akib Javed Khan
(On behalf of the whole study group)
Date
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Executive Summary
Capital budgeting is used to describe how managers plan significant outlays on projects those
have long-term implications such as the purchase of new equipment and the introduction of
new products. The concept of a companys cost of capital is used in capital budgeting as a
potential basic discount rate to be applied to expect future cash flows from a proposed
investment project being subjected to evaluation for acceptance or rejection. Discountedcash-flow capital budgeting techniques derive from valuation theory that determines present
value of expected future cash flows by discounting them down to the present at a discount
rate appropriate to the degree of risk involved. Conceptually, this is true with regard to both
domestic investment and foreign direct investment for any organizations of any country.
Capital budgeting practices of the companies in Bangladesh is more sophisticated than
numerous supplementary intensifying inhabitants. Factors approximating life arena of the
corporation, diligence, and magnitude calculated by paid up investment, variety of possession
and others plays a fundamental responsibility in the misjudgment of capital budget practices
in Bangladesh.
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There has been almost no study on capital budgeting and/or investment evaluation techniques
and practices of the companies in Bangladesh. Therefore, this exploratory study to review
capital budgeting practices in Bangladeshi companies is likely to bring out insights from an
untapped area of corporate finance in the context of a developing economy.
1.4. Objective of the Report:
Broad objective of this research is to elaborate on the capital budgeting practices of
Bangladeshi companies. For that purpose, the following specific objectives are pursued:
Identify to what extend different capital budgeting techniques such as NPV, IRR,
Payback Period, Discounted Payback Period, Profitability Index, Sensitivity Analysis,
Scenario Analysis, Real Options Approach, and Decision Tree Analysis are used.
Identify the extent of using different discount rates, risk adjusted and other.
Identify whether companies estimate their cost of capital or use a predefined discount
rate (as prescribed by corporate headquarters of multinationals or using several rule of
thumb)
Identify the risk factors usually taken into consideration to adjust cost of capital and
cash flows.
Evaluate the influence (if any) of some factors i.e. CEO/CFO background, tenure &
age and company size (measured by annual sales revenue) on the capital budgeting
practices.
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Chapter: 02 (Methodology)
2.1.
Data Collection:
0
1
2
.
Our data collection method was secondary basis. We collected information from web,
journals and various publications.
Usually published data are available in Various publications of the foreign and local governments.
Various publications of universities, international bodies and their subsidiary
organizations.
Technical and trade journals.
Report and publications of various associations connected with business and industry,
banks, stock exchange.
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2.2.
Data Processing:
Collected information is processed by the use of computer system. Detailed analysis, working
variables and working definitions are embodied in the report with the help of Microsoft
Office Applications.
2.3.
Data Presentation:
To present the data we have used Microsoft Office Applications.
We also used the graphical views and smart charts.
For preparing the presentation, PowerPoint application is used to present as slides.
3.1.
Capital Budgeting:
The total capital (long-term and short term) of a company is employed in fixed and current
assets of the firm. Fixed assets include those assets which are not meant for sale such as
land, building, machinery etc. it is a challenging task before the management to take
judicious regarding capital expenditures, i.e., investments in fixed assets to that the amount
should not unnecessarily be locked up in capital goods which may have far-reaching effects
on the success or failure of an enterprise. A capital asset, once acquired, cannot be disposed
of without any substantial loss and if it is acquired on long term credit basis, a continuing
liability is incurred over a long period of time, and will affect the financial obligations of the
company adversely. It, therefore, requires a long-range planning while taking decision
regarding investments in fixed assets. Such process of taking decisions regarding capital
expenditure is generally known as capital budgeting.
3.2.
Techniques
Used
in
Capital Budgeting:
The accounting rate of return that does not involve discounted cash flows. The method is also
the unadjusted rate of return, and the financial statement method. Accounting rate of return
(ARR) measures profitability from the conventional accounting standpoint by comparing the
required investment (sometimes average investment) to future annual earnings. Each
potential project's value should be estimated using a discounted cash flow (DCF) valuation,
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to find its net present value (NPV). This valuation requires estimating the size and timing of
all of the incremental cash flows from the project. The profitability index, by definition, is the
ratio of the present value of the benefits (PVB) to the present value of the cost (PVC). This
simple benefits-to-costs ratio will remove the scale effect's bias. We obviously prefer to invest
in the asset that has the higher value for the profitability index. The internal rate of return
(IRR) is defined as the discount rate that gives a net present value (NPV) of zero. It is a
commonly used measure of investment efficiency. The IRR method will result in the same
decision as the NPV method for (non-mutually exclusive) projects in an unconstrained
environment, in the usual cases where a negative cash flow occurs at the start of the project,
followed by all positive cash flows. The IRR equation generally cannot be solved analytically
but only via iterations. One shortcoming of the IRR method is that it is commonly
misunderstood to convey the actual annual profitability of an investment. The cost of capital
is a screening tool, in case of the Net Present Value Method and the cost of capital is used as
the discount rate when computing the net present value of a project. Any project with a
negative net present value is rejected unless other factors dictate its acceptance and in case of
the Internal Rate of Return Method, the cost of capital is compared to the internal rate of
return promised by a project. However, this is not the case because intermediate cash flows
are almost never reinvested at the project's IRR and therefore, the actual rate of return is
almost certainly going to be lower. Accordingly, a measure called Modified Internal Rate of
Return (MIRR) is often used. The payback is another method to evaluate an investment
project. The payback method focuses on the payback period. Payback is often used as a "first
screening method". By this, it is meant that when a capital investment project is being
considered, the first question to ask is: 'How long will it take to pay back its cost?' The bank /
company might have a target payback, and so it would reject a capital project unless its
payback period was less than a certain number of years. The payback period is the length of
time that it takes for a project to recoup its initial cost out of the cash receipts that it
generates. This period is sometimes referred to as" the time that it takes for an investment to
pay for itself." The basic premise of the payback method is that the more quickly the cost of
an investment can be recovered, the more desirable is the investment. A valuation method
used to estimate the attractiveness of an investment opportunity. Discounted cash flow (DCF)
analysis uses future free cash flow projections and discounts them (most often using the
weighted average cost of capital) to arrive at a present value, which is used to evaluate the
potential for investment. If the value arrived at through DCF analysis is higher than the
current cost of the investment, the opportunity may be a good one. Certainty Equivalent
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Technique is the common procedure for dealing with in capital budgeting is to reduce the
forecast of cash flows to some conservative level. Risk adjusted discount rate states that if the
time preference of money is to be recognized by discounting estimated future cash flows at
some risk free rate to their present value, then to allow for the riskiness of those future cash
flows at risk premium rate may be added to risk free discount rate such composite discount
rate.
3.3.
Capital
Budgeting
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.
3.4.
Nature
of
Capital
Budgeting:
Nature of capital budgeting can be explained in brief as under:
Capital expenditure plans involve a huge investment in fixed assets.
Capital expenditure once approved represents long-term investment that cannot be reserved or
withdrawn without sustaining a loss.
Preparation of coital budget plans involve forecasting of several years profits in
advance in order to judge the profitability of projects.
It may be asserted here that decision regarding capital investment should be taken very carefully so
that the future plans of the company are not affected adversely.
3.5.
Degree of Application of
Capital Budgeting Techniques in Bangladesh:
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A large majority of firms always or often use DCF methods which are recommended as
sophisticated techniques in finance literature. Of the different DCF methods, NPV and IRR
are most frequently (always or often) used methods followed by PI. Percentage of companies
frequently using NPV and IRR are respectively 88% and 79% whereas about 67% of the
companies frequently use profitability index (PI). In fact, PI is a technique to be used to
choose among competing investment opportunities, if there is limited financial resources
(capital rationing). Capital rationing especially hard rationing is not a regular phenomena, it
thrives only in case of weak financials and/or high risk of financial distress. Therefore, less
frequent use of PI makes reasonable sense from theoretical perspective. However, other DCF
method, discounted payback period (DPBP) is not widely used technique. Nearly half of the
firms studied rarely or never uses DPBP. In contrast to the heavy use of common DCF
methods, payback period (PBP) a rudimentary non-DCF technique is quite popular among
the respondent firms. 75% of the companies seen always or often use PBP, which is very
close to the usage of IRR technique. Among the risk adjusted methods sensitivity analysis
and scenario analysis are found to be almost equally applied techniques, being frequently
used by 49% and 44% firms. But decision tree approach and real option approach are rarely
or never used by majority (62% and 70% respectively) of the local firms.
In terms of broad category DCF and non-DCF methods are almost equally used methods. In
comparison to the risk adjusted methods, DCF and non-DCF methods are more commonly
used by the most firms.
3.6.
Factors
Influencing
frequently use non-DCF methods, followed by DCF and risk adjusted methods respectively.
Company discount rate is most frequently used as the rate for discounting cash flows of
investment opportunities by companies with CEO/CFOs of age between 50-59; tenure above
9 years and having (business or non-business) masters degree. Majority of the companies
rarely use country specific or divisional discount rate irrespective of their CEO/CFO
background. Companies with CEO/CFOs of age between 40-59; tenure between 4-9 years
and having business masters degree frequently adjust discount rate for country, industry and
other risks.
Very few companies use different discount rates for cash flows having different risks.
Company size, measured in terms of sales revenue does not have any impact on the choice of
discount rate. CEO/CFO background or company size does not have any impact on the
frequency to taking decision contrasting to that derived by capital budgeting techniques.
3.7.
Capital
Budgeting
process of estimating cost of capital, which is a crucial input in capital budgeting methods.
There are some factors like life stage of the company, industry, size measured by paid up
capital, type of ownership and others plays a vital role in the misjudgment of capital budget
practices in Bangladesh.
3.8.
Capital
Budgeting
3.9.
Capital
Budgeting
in
Indication of Capital
Budgeting Practices in Bangladesh:
Almost all firms in Bangladesh use several techniques in parallel. But not
all of them properly use the techniques of capital budgeting for their
organizational risk adjustment. Excluding, some of the large firms like Reckitt
Benckiser, Beximco Pharma, Grameenphone Limited etc have established a great
example of practicing capital budgeting technique. In addition, there is a very
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Conclusion
Capital budgeting is a continuous process and it is carried out by different functional areas of
management such as production, marketing, engineering, financial management etc. Although
most of the firms and organizations in Bangladesh do not adequately follow the capital budgeting techniques,
we as group think that they should properly follow and practice the capital budgeting techniques in their
respective institutions. This report encompasses concise and precious review on the capital
budgeting practice and its superior correlation with monetary progress of Bangladesh and
Bangladeshi companies. Capital budgeting decision requires planning for setting up budgets
on projects expected to have long-term implication having entailed its approaches/ techniques
significantly is applied in banking sector. Now a day, the techniques of capital budgeting are
systematic. The companies or any organizations cannot control over the operation of them as
per plan beyond the meaning full capital budgeting decision and application of capital
budgeting techniques. So, capital budgeting decision and practice of capital budgeting
techniques bear the significance and importance for successful operation of corporate
business along with any other business.
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References
https://www.scribd.com/doc/29593117/Multinational-Capital-Budgeting
https://www.scribd.com/presentation/14554486/Capital-Budgeting
https://www.scribd.com/doc/17738379/Capital-Budgeting
http://www.assignmentpoint.com/business/finance/capital-budgeting-tools-and-
technique.html
http://www.termpaperwarehouse.com/essay-on/Capital-Budgeting-Practice-InBd/342082
file:///H:/SEU/production/235228517_CAPITAL_BUDGETING_FOR_FOREIGN_D
IRECT_INVESTMENT_BANGLADESH_OVERVIEW.htm
file:///H:/SEU/production/application-of-inventory-management.html
http://www.assignmentpoint.com/business/finance/capital-budgeting-tools-andtechnique.html
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