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 o f ch ange in
investments or sales.
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

Journal of Contemporary Research in Management, January - March 2008 17

 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.
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 decision-
making 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
18 Journal of Contemporary Research in Management, January - March 2008
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.
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
2. To assess the growth rate in the fixed
investment pattern of the company
3. To trace out the influencing factors on
fixed investment and financing trend
of the company
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
Journal of Contemporary Research in Management, January - March 2008
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, 2000-
19
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 Fixed Assets Percent of Classification
Assets at increased Increase
the beginning during the year
of the year
1998-99 8935.22 1665.49 18.64 G
1999-00 9150.34 1076.98 11.77 R
2000-01 8915.41 1050.12 11.78 R
2001-02 9560.99 1613.16 16.87 G
2002-03 9025.19 1326.53 15.00 G
2003-04 8748.29 792.08 09.05 R
2004-05 8938.46 1796.95 20.10 G
2005-06 9432.71 2426.32 25.72 G

As we can see form the table 2, the
annual rate of growth in fixed statements
and their classification. In the year 1999-
00, 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.
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.

The amo unt of i ncre mental Accountable Factors for Fix ed

investments increased its height in 2005- Investment: The purpose of Investments

20 Journal of Contemporary Research in Management, January - March 2008

differs one to another firm. For example, production, and promotion programmes
the purpose of expansion is to meet the provides the demand for the product goes
growing demand for products; the purpose up in the market. This has been proved by
of modernisation helps to reduce the cost this company as it occupies the good
through new production processes; and position in the market. From the analysis,
diversification helps to additions to existing it is clear that the fixed investments and
product line. All these forms help to sales have the close and direct relationship
increase the sales, in turn to increase between each other.
profits of the companies in the long run.
b. Fixed investments and profit: As
In this study, we have tried to correlate
we mentioned above, increase in fixed
each internal factors such as sales, profit
investment is to enhance the earning
and depreciation charges with fixed
capacity of the company. It is clear from
investments. 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
(Figures in Millions)
Financial Year Incremental Fixed Sales Profit Depreciation
Investments
1998-99 1665.49 20450.71 -120.62 690.40
1999-00 1076.98 25987.18 805.86 641.42
2000-01 1050.12 26066.63 913.77 784.41
2001-02 1613.16 26304.48 1172.31 765.02
2002-03 1326.53 30739.95 1634.78 1752.18
2003-04 792.08 39272.73 2773.59 912.63
2004-05 1796.95 48112.82 3108.38 1075.91
2005-06 2426.32 60531.08 3976.11 868.24
Mean 1468.45 34683.20 1783.02 936.28
SD 519.76 13668.07 1377.19 356.61
CV 282.52 253.75 129.47 262.55

Journal of Contemporary Research in Management, January - March 2008 21

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 Correlation (r) t Value for r Table Value @ 5 D.F Results

Between per cent level

FI & Sales 0.60 4.5 1.895 6 Ho Rejected

FI & Profits 0.43 2.86 1.895 6 Ho Rejected

FI & -0.01 -0.06 1.895 6 Ho Accepted

Depreciation

Sales & 0.97 23.94 1.895 6 Ho Rejected

Profits

Sales & 0.16 0.97 1.895 6 Ho Accepted

Depreciation

Profits & 0.26 1.62 1.895 6 Ho Accepted

Depreciation

d. Sales, profits and depreciation at 5 per cent level of significance. The

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
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.

22 Journal of Contemporary Research in Management, January - March 2008

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
Journal of Contemporary Research in Management, January - March 2008
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